Economic literature

review
Internet shopping – Annexe F

June 2007
A report for the Office of Fair Trading by
Europe Economics

OFT921f

1
© Crown copyright 2007

This publication (excluding the OFT logo) may be reproduced free of charge in
any format or medium provided that it is reproduced accurately and not used in
a misleading context. The material must be acknowledged as crown copyright
and the title of the publication specified.

The views expressed in this report are those of the authors, and do not
necessarily reflect the views of the Office of Fair Trading.

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CONTENTS

Chapter Page

1 Executive summary 2

2 Introduction 7

3 The development of internet shopping 13

4 Consumers and internet shopping 17

5 Company behaviour 31

6 Conclusions 63

A1 Bibliography – all articles considered 68

A2 Bibliography – articles shortlisted 85

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1 EXECUTIVE SUMMARY

Background

1.1 This report provides a review of academic economic literature and

related media assessments of the development of internet shopping. This
research was commissioned by OFT as a follow up to a study on e-
commerce and its implications for competition carried out in 2000 by
Frontier Economics.

1.2 Over 250 articles were identified in an initial literature search and these
were reviewed at a high level on the basis of abstracts or summaries of
contents. A shortlist of about 40 articles was identified on the basis of
their relevance to the main topics of interest to OFT. These were subject
to detailed review and the findings of these articles provide the main
input to this report.

The development of internet shopping

1.3 Internet shopping has grown almost five-fold since 2000. It still only
accounts for just over three per cent of total retail sales but this share is
higher in certain sectors. Nearly two-thirds of consumers are internet
users and over half of these had used the internet to make purchases.
Convenience of use is an important factor in purchasing decisions but
concerns about security of payment and delivery arrangements are seen
as negative aspects of the internet.

1.4 The growth of broadband access has been an important driver of change
both for consumers and for business. The speed of response available
has been an important factor in the growth of search engines and price
comparison sites.

1.5 Traditional retailers have responded to the growth of internet sales by

successfully developing their own online businesses. There is
considerable interaction between the different forms of business model
adopted with business models changing in response both to business
and consumer behaviour.

2
 Consumers and the internet

1.6 Online consumers tend to be younger, better off and better educated
than their offline counterparts. Higher computer literacy makes internet
shopping more attractive. Their familiarity with the internet also makes
them better placed to identify and take advantage of lower priced
products. However in 2005 growth in the numbers of people shopping
online was highest for the over 55 year old and the lower social classes.

1.7 Consumers are most attracted to the internet for products like books,
CDs and PCs where the attributes of the product can be clearly identified
online. For low priced products such as CDs the convenience offered by
the internet is an important factor. For products requiring direct contact
– 'high touch products' – or for which service and delivery are important
factors the internet is a less attractive shopping channel.

1.8 Price is an important factor in buying online but consumers have been
found to be willing to trade off convenience and price. Other factors
such as reputation, trustworthiness of the retailer and quality of
information are also important to consumers. The internet provides an
alternative shopping channel to traditional retailing. However, there are
also circumstances in which both channels are complementary with each
meeting a part of the consumers' needs to acquire information and
understand products before making a purchase either on- or offline.

1.9 The increased availability of information is generally a significant benefit

to consumers. However research has also identified ways in which the
information may be distorted, for example through selective provision,
and the consumer benefit reduced.

1.10 Price search engines are widely used to identify lowest priced retailers
but this does not necessarily lead to the lowest priced products being
purchased. Research suggests that consumers use the search engines as
an initial screening mechanism but then apply other criteria than lowest
price in making their purchase.

1.11 Because convenience and trust in retailers is important online, regular

consumers may limit their searches to suppliers that they have
purchased from in the past. There may be a high cost to getting
consumers to switch supplier in these circumstances.

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1.12 Given the quantity of information available and the cost, in time, of
making additional searches, it appears that consumers take advantage of
additional information up to a certain level but reach a point at which
they do not place a value on further information.

Company behaviour

1.13 A range of business models have been developed to take advantage of

the different cost structures of internet retailing and new opportunities
to interact with customers. There appears to be considerable interaction
between online and offline retailers and business models are subject to
continuous adaptation in the face of market changes. We have not found
evidence that any one model of internet retailing has a particular
advantage.

1.14 Provision of information through various types of search facility has

developed as a new commercial activity. Information is provided free and
revenue is generated from companies whose details have been accessed
in the search process. The way in which such revenue is generated is
not well documented in the literature reviewed.

1.15 Pure play internet operators have generally (but not always) offered
lower prices. At the same time operators with both online and offline
outlets have generally been able to maintain higher prices online than
their pure play competitors.

1.16 Early views that the internet would provide a 'frictionless' competitive
market have not been realised. There is a substantial body of evidence to
show that there is a considerable degree of price dispersion for similar
goods both between internet sites and between on- and offline sales. A
number of reasons for continuing price dispersion have been considered.
These include quality factors, convenience, variation in consumer
awareness and factors affecting consumer trust in particular retailers.

1.17 Price dispersion does not necessarily imply that prices are above
competitive levels. Further investigation would be necessary to establish
the reasons for price variation. Non-price factors may provide a rational
explanation but research has also identified market structure and
differences in access to information as possible explanations.

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1.18 The internet allows retailers to obtain a large amount of information
about consumer behaviour and preferences. This coupled with the ease
with which prices can be changed online provides the opportunity to
tailor product offerings to individuals or groups of individuals. This has
focused attention on whether the internet offers new opportunities for
price discrimination. This is a general concern rather than one based on
clear evidence at this stage. It is also possible that some element of
price discrimination may expand markets and be of benefit to
consumers. Bundling of products, particularly information goods may be
used by firms as an alternative to overt price discrimination.

1.19 Vertical integration has not been a major feature of internet shopping.
However there have been some suggestions that manufacturers might
seek to limit the supply of certain goods to internet outlets in order to
protect traditional retailers. This is not an issue which is unique to
internet shopping but has the potential to restrict competition and should
be kept under review.

1.20 The internet also provides companies with a significant amount of

information about each others behaviour. This provides material which
could be used to support price collusion. However collusion generally
requires the existence of a wider set of conditions if it is to be
sustainable. It is not clear that all of these conditions are satisfied in the
circumstances of internet retailing.

1.21 Building brand recognition and consumer trust have been recognised as
particularly important factors in attracting and retaining internet
shoppers. That may require substantial investment which may be higher
for online than for offline trading. This could give early entrants an
advantage and provide a barrier to entrants at a later stage.

Market definition

1.22 Market definition has not been addressed directly in the literature
reviewed but a number of general points can be identified particularly
from the literature on price dispersion. In general it appears that the
internet forms part of the total retail sector. For competition policy
purposes this would normally be considered on a product by product
basis through an examination of price sensitivity. While there are
products which appear more suited to internet trading than others, we

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 have not identified areas where the internet should be regarded as
constituting a separate market. There is no indication that there is any
requirement to develop new approaches to market definition in
considering the operation of competition.

Areas for further work

1.23 Internet shopping continues to grow rapidly and there is evidence that
this is beneficial to consumers in terms of lower prices, increased access
to information and increased choice. However the continued existence of
price dispersion, the way firms may be able to influence information
flows and the potential for price discrimination and tacit collusion have
all been identified as issues which should be kept under review. Targeted
studies of individual products and of the persistence of price differentials
could provide a focus for monitoring developments.

1.24 There are certain aspects of internet retailing which have not been the
subject of the research covered in this review. Concerns were expressed
in the past in the Frontier Economics report that network effects could
result in dominant players and barriers to entry. This has not emerged
from the literature as an issue in the development of internet shopping to
date although the related issue of potentially high start up costs has
been highlighted as a possible barrier. Network effects are likely to be
particularly important in the development of internet auction sites.
Further research could be considered to establish if competition is likely
to be restricted.

1.25 Access to information is one of the defining benefits of the internet but
little attention has been given to the way in which search engines and
other information sites manage and finance that information. This too
could be the subject of further research to establish whether the benefit
to consumers from information flows is in any way being restricted.

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2 INTRODUCTION

Background

2.1 In 2000 The Office of Fair Trading (OFT) commissioned Frontier

Economics to carry out a review of the development of e-commerce and
its implications for competition.1 The report examined three elements,
market definition, market power and individual agreements and conduct.
It concluded that e-commerce was unlikely to develop entirely new
forms of anti-competitive behaviour that could not be dealt with under
existing competition law. A number of areas would require careful
monitoring and that in some cases detailed application of competition
law might require some adjustment.

2.2 Principal findings from that report were that:

• many of the characteristics of e-commerce and associated patterns

of behaviour will tend to lower barriers to entry into both B2C and
B2B e-commerce, reducing the potential for players to secure and
exploit market power

• there are certain characteristics of e-commerce which may tend to

raise barriers to entry such as:

- sunk costs of establishing consumer loyalty - reputation,

branding and customer loyalty will become increasingly important
and may create significant first-mover advantages. These could
be reduced if customers were able to 'port' their own database
entries from site to site

- 'Tippy' markets - Online marketplaces may tend towards being

natural monopolies and a second potential entrant may face large
barriers to entry. These barriers will be particularly high in
markets where liquidity is important and exacerbated where
market participants are tied into the market via proprietary supply
chain management systems. The 'tippiness' of online
marketplaces will be strongly affected by the ability of market
participants to monitor different marketplaces and to switch
easily between them. Intermediaries could facilitate this

1
Frontier Economics, 2000

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 - even where first mover advantages persist, they need not imply
market power if operators compete in a wide product market that
includes traditional commerce, and if barriers to entry into the
traditional service are low

- increased buyer power will tend to limit the extent to which high
market shares and barriers to entry will confer market power.2

2.3 Since publication of that report there has been continued development in
the use of the internet for business purposes and the elapse of time has
provided the opportunity for further research into consumer and business
behaviour. In order to provide a basis for assessing the impact of the
internet on competition OFT commissioned Europe Economics to carry
out a review of the published literature on internet shopping. The overall
purpose was to gather and review evidence on how internet shopping is
developing and specifically to review the empirical literature to
understand how internet shopping has affected:

• the nature of the buying and selling processes

• the process of competition (either positively or negatively)

• the nature of consumer detriment (if at all), in particular what, if any,

evidence exists on the scale of the detriment, and

• the nature and scale of any resulting consumer benefits.

2.4 OFT was also interested in understanding key developments which might
be expected in these areas.

Approach to the Literature Review

General approach

2.5 The principal focus of this study is on reviewing empirical literature on

the impact of internet shopping in order to provide an up-date on key
developments in economic theory and analysis relevant to the subject.

2.6 Our initial focus has been on the published economic literature on
internet selling, in particular retail sales. We have also looked at a range

2
OFT Press Notice, 2000

8
 of economic media reports with a focus on analytical comment rather
than news reporting. A number of UK and US government and EU and
OECD reports have been reviewed.

2.7 Internet and database searches were made using keywords, for example
internet shopping, e-commerce and e-tailers. These were used
individually and in combination with particular competition issue search
words for example price discrimination, IPR, tipping, regulation.

2.8 Given the pace of change in the development of the internet as a retail
channel there is a danger that the findings of research may have been
overtaken by events by the time of publication. We kept this caveat in
mind in reviewing the literature. For media and Government material we
focused mainly on publications in the last two to five years. That
restriction was not applied to the academic literature although in practice
direct analysis of the internet only began in the mid 1990s. There are
references to seminal earlier articles or books – for example, G Stigler
1961, The Economics of Information – which provide a theoretical
framework for analysing the internet. These have not been included in
the review.

The economic literature

2.9 The LSE library provided us with access to a wide range of relevant
databases of economic journal articles and working papers. These have
been searched using the key words as described above. Some 250
articles were identified in this way. A full list of articles is set out in
Appendix 1.

Sifting

2.10 The keyword searches provided a crude initial filter for identifying
relevant articles. We then narrowed this list down to a short list of key
articles which were the subject of more detailed review.

2.11 We applied a number of criteria in developing our shortlist. The abstract

of each article was used to identify the coverage of issues relevant to
the study (using the areas of interest listed by OFT). Articles focused on
other aspects of the internet, for example, solely on B2B or on internet
taxation, were excluded. We identified whether studies were theoretical
or empirical (or a mix). We gave greater weight to empirical studies but

9
 did not automatically exclude the theoretical papers if they addressed
relevant issues. We gave preference to more recent articles because
these are more likely to be relevant to a rapidly changing area of
business. In particular we considered whether the most recent paper by
a particular author superseded earlier work. We gave greater weight to
articles in peer reviewed journals than to working papers.

2.12 However none of these criteria was applied in a rigid way. Nor did we
attempt to apply a rigid scoring system. Our selection was based on the
team's collective judgment of each article. We then cross-checked the
bibliographies in the selected articles to ensure that we were not
overlooking seminal papers and as a result identified some additional
material to consider.

2.13 On this basis we identified a shortlist of 41 priority articles which were

subject to detailed review and which form the basis for the findings set
out in the rest of this report. These articles are listed in Appendix 2.

Quality

2.14 For the economic literature the principal external check on quality was
simply whether the article had appeared in a respected peer reviewed
journal or was at the earlier stage of working paper or mimeo. Where
possible we made our own assessment of the strengths and weaknesses
of each article. However given the volume of the material reviewed,
some of it using complex modelling, we cannot claim to have carried out
a detailed critique of each article.

2.15 In looking at media and trade comment it is easier to identify the extent
to which each piece is seeking to present an objective analysis. Much of
the material, with some exceptions, is clearly written to present a
particular point of view or promote an individual company position. While
this may provide interesting anecdotal material which can illustrate a
point which has emerged from more considered analysis, it must be used
with caution. The market research work we examined fell into a middle
ground. The major surveys are likely to have been well conducted using
appropriate techniques for collection and analysis of data but the
commentary on what such data tell us about market development may
tend to be short term and may not be set in a clear market framework.

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 Summary of coverage

2.16 A summary of the coverage of the articles which were subject to

detailed review is set out in Table 2.1 This shows the extent to which
particular issues were addressed in this literature. Some issues such as
consumer behaviour and effects of quality/quantity of information have
reasonably good coverage; others such as tipping and IPR do not feature
at all.

Table 2.1

Issues Frequency
Business models for internet retailing. 20
The internet as substitute or complement to traditional shopping and 15
factors affecting use.
Effect of quantity and quality of online information on competition. 14
How consumers search for and select suppliers. 13
Rationality of consumer behaviour. 9
Internet retailing and collusion. 7
Price discrimination by internet retailers. 6
Use of vertical restraints. 3
Barriers to entry into internet retailing. 3
Refusal to supply or special conditions for internet retailers. 2
Tipping points in internet markets. 0
Intellectual Property Rights (IPRs) and the development of internet 0
shopping?

Structure of the report

2.17 The following sections of this report set out our findings from the
literature review. We provide an overview of the development of internet
shopping based on published statistics, market research, industry and
media comment. The principal academic research findings and key issues
arising are reviewed under the headings of:

• Consumer issues

• Business models

• Pricing developments

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 • Other aspects of company behaviour.

2.18 The final section brings together main findings and areas for possible
further attention.

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3 THE DEVELOPMENT OF INTERNET SHOPPING

Growing use of the internet

3.1 Computer ownership and internet access in UK households has increased

significantly over the past five years. In January 2005, 62 per cent of
households in Great Britain could access the internet at home compared
with only nine per cent in 1998-99.3 Broadband connections now
account for about 60 per cent of all connections.4

3.2 Alongside this growth in household high-speed access to the internet

there has been a very rapid growth in internet shopping. In 2004 internet
sales made to UK households by UK non-financial sector businesses
were valued at £18.1 billion, an increase of 68 per cent on the previous
year. This compares with sales of around £3 billion in 2000.5 Trade
comment suggests that rapid growth has continued in 2005.6 However
a recent Mintel survey paints a more cautious picture suggesting that the
rate of growth in internet sales, while continuing, has slowed down and
is now largely in line with growth in consumer internet connections.7

3.3 The same Mintel report notes that the Internet has not transformed the
face of retailing to quite the extent predicted five years ago but that it is
continuing to establish itself as something more than just a niche retail
channel. In this respect, it is obviously of more importance to some
sectors than others, something that to a large extent is determined by
the relative ease or difficulty with which an online order can be fulfilled.

3.4 UK internet retail sales in 2005 represented 3.1 per cent of total retail
sales of businesses. This share had risen from 0.1 per cent in 1997.8
Industry projections suggest that retail sales on the internet could rise to
£21.5 billion by 2010 and represent over 6.8 per cent of all retail sales.9

3
Office of National Statistics (ONS), Expenditure and food survey, 2005

4
ONS Survey of Internet Service Providers, 2005
5
ONS Annual e commerce survey, 2004
6
Interactive Media in Retail Group (IMRG), e-retail, 2005
7
Mintel Internet Quarterly, 2005
8
Verdict e-Retail Report, 2005
9
Verdict e-Retail, 2005

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3.5 In the US retail e-commerce sales were estimated to total $81.8 billion in
the year to end September 2005, about 25 per cent up on the previous
year. This compares with overall annual growth in retail sales of around
two per cent. E-commerce sales now represent about two per cent of all
US retail sales.10

Patterns of use

3.6 A recent survey indicated that over 60 per cent of consumers were
regular users of the internet.11 Nearly all of these respondents had used
the internet for finding information about goods and services and over
half had used it to make purchases. The internet is now more popular
than mail order as a channel for home shopping.12 The most popular
purchases are books and CDs.13

3.7 Use of general search engines is the predominant means of acquiring

information. Google accounted for 70 per cent of searches for all types
of information with Ask, Yahoo and MSN Search accounting for almost
all of the remainder.14

3.8 In a survey by the Welsh Consumer Council in 2005, the principle reason
cited by Welsh shoppers for using the internet was convenience (77 per
cent). Forty per cent cited value for money or lower prices and over a
quarter said they liked being able to shop around for best buys. More
choice or variety was only mentioned by three per cent of internet
shoppers.15 By contrast, in an Oxford Internet Survey in 2005, 78 per
cent of British internet users agreed with the statement that 'shopping
on the internet offers more choice' and 73 per cent agreed that 'the
price of things on the internet are lower'.16

3.9 A survey article in The Economist in 2004 noted '… the extraordinary
influence the internet is exerting over purchases carried out in the offline
world. That influence is becoming an integral part of e-commerce…
What is going on is arbitrage between different sales channels.

10
US Department of Commerce, Census Bureau, 2005
11
ONS, 2005
12
Mintel, 2005
13
APACS, 2005
14
Hitwise, 2005
15
Welsh Consumer Council – Internet Shopping: the consumer perspective - 2005
16
Oxford Internet Institute, 2005

14
 Consumers are 'unbundling' product information from the transaction
itself…Shops are moving to become showrooms.' 17 This trend is
confirmed in the IMRG review in October 2005.

3.10 Nonetheless the bulk of internet shopping remains concentrated in a

relatively small number of product sectors. Mintel's quarterly survey of
internet shoppers indicates that there were only four sectors – books,
music, entertainment tickets and travel – where more than one quarter
of these shoppers had actually made purchases.

3.11 The principal consumer concerns about internet shopping were:

• security of payments (58 per cent)

• ability to make warranty claim or get refund (37 per cent)

• aspects of delivery (34 per cent).18

3.12 In 2005, Consumer Direct received 23,727 complaints in relation to

internet purchases, including those bought from internet auctions. This
represented 7.6 per cent of all complaints in that period.

Market developments

3.13 In a rapidly growing market there is likely to be considerable scope for

innovation. The dot.com boom (and bust) which preceded the major
growth in internet commerce is an indication both of the opportunity to
innovate and of entrepreneurs' willingness to engage with the new
market opportunities. Innovation has continued in recent years, possibly
more incremental than radical, and a number of features stand out from
media and industry comment.

3.14 The continuing penetration of high-speed broadband internet access has

been an important driver of change both for consumers and businesses.
Speed of response has made the search for product information much
easier and more attractive. This in turn has driven the growth of search
engines, notably Google.com, and of price comparison sites (often
known as shopbots) such as shopping.com. A number of business

17
The Economist, May 2004
18
European Opinion Research Group, 2004

15
 models have been developed through which search and comparison sites
can derive revenue from businesses in return for exposure to potential
customers.

3.15 A number of pure play (internet only) retail businesses survived the
dot.com collapse and have continued to develop. Amazon and eBay are
the best known international examples. Both companies are now
diversifying away from their original focus to develop wider retailing
interests while remaining pure play operators.

3.16 Traditional bricks and mortar operators have progressively increased their
online activities. Walmart.com is now the fourth largest US internet
retailer presence (after Amazon, eBay and Shopping.com).19 Barnes and
Noble has developed a substantial internet book and CD business as a
response to Amazon. In the UK, PC World operates in both traditional
and online mode and is encouraging customers to make use of both
channels, for example by offering buy on line – collect in store options.
The counterpart of this latter development is the move towards using
traditional shops as showrooms with purchases taking place online.
Apple has been a leading exponent of this approach.

19
Financial Times, 7 June 2005

16
4 CONSUMERS AND INTERNET SHOPPING

4.1 This section discusses consumers' use of the internet as a shopping

channel.

4.2 Specifically we draw on the reviewed literature to:

• understand factors that drive consumers’ use of the internet as

opposed to or in conjunction with traditional bricks and mortar
shopping routes

• draw lessons on consumers search for and selection of online

suppliers, how consumers use information in their search, and what
use is made of different kinds of online search engines, and

• consider whether consumers behave rationally in their online

shopping.

Online — offline decision

4.3 Various authors have examined the main factors that influence
consumers' use of the internet for shopping purposes, as well as the
choice between online shopping and shopping in traditional bricks and
mortar outlets.

Direct investigations of consumer decision making

4.4 Studies from the late 1990s, such as Smith et al, on the factors leading
to online purchasing suggested that online consumers are willing to
trade-off convenience and price.20 Retailers who make it easier to find
and evaluate products (for example by better search tools or website
design) may be able to charge a price premium to time sensitive
consumers.

4.5 More recently it has also been found that on average online shoppers
appear to:

• be younger, wealthier and better educated than their offline

counterparts

20
Smith et al (1999)

17
 • have higher computer literacy, spend more time on their computer
and on the internet

• find online shopping easier and more entertaining, and

• are less fearful of financial loss from online shopping.21

4.6 Those who actually purchase online (as opposed to using it for example
purely for search purposes) appear to have been using the Internet for a
longer time, to be more frequent web uses and to spend more time on
the Internet in general. However a recent Verdict e-retail report indicates
that in 2005 growth in the numbers of people shopping online was
highest for the over 55 year old and the lower social classes.22

4.7 These studies further compared different categories of benefits and

costs of online and offline shopping. The following factors were found to
be more important in online than offline context:

• built or perceived reputation and trust in the supplier

• increased convenience and control over purchases

• better information, and

• the general quality of the merchandise.23

4.8 On the other hand, enjoyment of the experience and service quality has
been found to be of less importance to online shoppers compared to
offline shoppers. Koyuncy and Bhattacharya found that consumers
regarded the longer delivery time for the items bought online and the
perceived risks involved in online payment as negative features of
internet shopping.24

4.9 The evidence on the relative importance of price in choosing whether to

shop on or offline is ambiguous. There is evidence in research by Keen et
al that the availability of lower prices has led individuals to increase their

21
For example Bailey (1998), Broekhuizen and Jager (2004) and Brengman et al. (2003).
22
Verdict e-Retail, 2005.
23
This could perhaps be because perceived risk associated with products inspected online is
lower the higher the quality of the products.
24
Koyuncy and Bhattacharya, (2004).

18
 shopping from the Internet. Price is undoubtedly an important factor in
many decisions to shop online but product and other characteristics have
also been found to be important factors. 25

4.10 Keen et al made an assessment of what motivates consumers to shop

using a particular retail format. They examined consumers' decision
making processes on whether to purchase both CDs and PCs in store,
from a catalogue or on the Internet. This study found that for lower
cost, lower risk items such as CDs, the convenience offered by the
internet retail format may outweigh price differences. With high cost
items, consumers prefer to shop around for a better price. The main
decision variables in consumers' decision were found to be the retail
format (store, catalogue, or Internet) and the product price. The authors
found both of these factors twice as important as the possible other
factors including ease of use, control over purchase, and retailer attitude
(positive or negative). This suggests that the retail format itself and not
simply factors such as relative price is one of the main decision factors.
Consumers make a positive choice to purchase either online or offline.

4.11 Similar analysis, by Levin et al, using a multipart survey of students and
an online panel asked respondents to rate their likelihood of shopping
online or offline for each of a series of products.26 They were asked to
take into account a number of attributes associated with shopping both
at the search stage and at the purchase stage. They were asked to rate
the importance of attributes that might be of particular importance for
certain products like clothing and books, and to rate the extent to which
they thought each attribute was delivered better online or offline.

4.12 Several earlier studies had shown that 'high touch' products that
consumers feel they need physical experience with require an offline
presence, at least at the final purchase stage.27 At the other extreme,
'low touch' products like airline tickets or computer software are
products that favour online services both because of the nature of the
product and the importance of shopping quickly. Preference for shopping

25
Keen et al (2004).
26
Levin et al (2005).
27
This does, however, contrast with suggestions from other studies, described below, that
traditional stores may be used as 'show rooms' for high touch products that consumers then
purchase online.

19
 online has been found to be particularly strong for products like books
and PCs where most attributes can be determined online.28

4.13 The findings of the Levin study were consistent with this earlier
evidence:

• the respondents rated attributes related to the search process, such

as shopping quickly, having a large selection of products and best
price as being better delivered online than offline. On the other hand,
attributes related to experience with the product (such as the ability
to see, touch or handle the product) and attributes related to the
delivery process, such as personal service and speedy delivery, were
rated as being better delivered offline than online

• based on perceived risk of online transactions, the preference for

online shopping was weaker at the purchase stage than at the
search stage, so that more shoppers will search for products and
information than actually complete purchases online.

4.14 Differences in levels of information held between the consumers may

also be a decisive factor in the choice between online and offline
shopping, as modelled in Bakos et al.29 Informed consumers may more
readily opt to purchase goods or services cheaply online. Less informed
customers may be content to pay more for a bundled offering where
research, advice or other forms of service are provided as part of the
sales package.

Lessons from welfare and pricing studies

4.15 In general, pricing studies have found both higher and lower prices being
charged online than offline, with considerable price dispersion remaining
in online (these, and the potential explanations for the dispersion, are
discussed further below and in the Section 5). For example, Brynjolfsson
and Smith found that Internet retailers charge lower prices than
conventional retailers.30 This held both for prices alone and for prices
including the costs of getting the item to the users’ homes (for example

28
Chiang and Dholskia (2003); Lynch, Kent and Srinivasan (2001); and Girard, Silverblatt and
Korgaonkar (2002), all referenced in Levin et al (2005)
29
Bakos et al (2005)
30
Brynjolfsson and Smith (2000)

20
 shipping and handling fees, taxes, and mileage costs). Lower overall
costs for obtaining the same products, where available, clearly is a
reason for shopping online rather than offline.

4.16 This is supported by results from a Goolsbee study using survey data
from 90,000 US households to examine how offline retail price of
computers influences the probability of buying computers online.31 The
study simultaneously controlled for the potential effects of factors such
as general cost of living, age, education, number of cars and whether
the purchase was made online or offline. It found that the decision to
buy computers online was sensitive to the relative price of computers in
retail stores.32

4.17 This would suggest that online and offline computer retailers compete
against each other. Changes in online prices themselves, however, were
not found to be a significant factor in the decision of whether or not to
buy online. The effect was also found to vary by the type of consumer
and the type of computer purchased. Experienced computer users and
customers purchasing desktop computers were found to be more
sensitive to differences in prices between offline and online suppliers.
Being more educated was to an extent positively associated with online
purchasing, while being older decreased the probability of buying online.

4.18 Pricing studies have also explained the existing price dispersion and
higher online prices compared to offline counterparts by the existence of
the other significant decision factors, such as convenience, discussed in
the direct investigations of consumer decisions described above. For
example Chun and Kim found that if inconvenience associated with the
online purchase decreases, the online price tends to exceed the offline
price.33

4.19 Studies on consumer welfare effects provide further evidence on why

consumers shop online rather than offline. Analysis of relative welfare
effects of online book retailers by Brynjolfsson and Smith found that the
Internet improves the welfare of consumers by allowing them to locate

31
Goolsbee (2001)
32
The cross-price elasticity between offline and online retailers was found to be 1.5
33
Chun and Kim (2005)

21
 and buy speciality books they otherwise would not have purchased due
to high transaction costs or low product awareness.34

4.20 Estimating the value that consumers place on increased product variety
for obscure book titles, the study finds that increased online availability
of previously hard-to-find products represents a very significant positive
impact on consumer welfare. The increased online availability of
previously hard-to-find products represents a positive impact on
consumer welfare that is seven to ten times larger than that found by
the authors' previous research.

4.21 Ability to search for and gain access to a larger variety of goods,
including obscure and rare items, may therefore be a major factor in the
decision to shop online.

4.22 These findings broadly support the findings in the Frontier Economics
report that open access to information on products was beneficial to
consumers but that the complexity involved on product information
could lead to some loss of price transparency.

Complementary use of the online and offline channels

4.23 The discussion above considered the use of online and offline channels
as substitutes for one another. The two however are also being used by
consumers in conjunction with each other.

4.24 The Internet can play an information discovery and price comparison role
so that consumers enter traditional retailers more informed. Consumers
can educate themselves about features and prices online, or use referral
services, potentially leading to final price improvements. For example an
investigation of the effect of internet car referral services on dealer
pricing of automobiles in California by Scott-Morton et al suggested that
users of internet purchase referral sites to buy a car paid on average two
per cent less than offline customers.35 Dealer margins on the sale of a
vehicle through the referral service were significantly lower than margins
earned selling the vehicle in the traditional way. A quarter of consumer
savings came from purchasing at low-price dealerships affiliated with the

34
Brynjolfsson and Smith (2003)
35
Scott-Morton et al (2001)

22
 online service. The remaining reduction came from the information
provision by the online service, bargaining by the referral service on
behalf of customers and cost efficiencies.

4.25 The Internet has been also been found to play a role in price discovery
and affected the prices of life insurance. Increases in Internet use
significantly reduced the price of term life insurance.36 A survey in The
Economist discussed how the Internet is changing consumer behaviour
with an increasing number of consumers researching their purchases
online before buying them in conventional stores.37 A study by Zmud et
al concluded that internet shopping was not necessarily a substitute for
traditional shopping and could even lead to an increase in the number of
trips for shopping purposes.38

4.26 Complementarity between the online and offline formats of shopping can
also work in the other direction, where traditional stores may be used as
'show rooms' by companies whose consumers then buy online, as
suggested by Borenstein and Saloner.39 In this case online suppliers can
free ride on the experience provided by the showrooms and traditional
retailers may seek to respond by restricting the availability of their
products to online suppliers. This issue is considered further in Section
5.

4.27 It seems therefore that consumers can use traditional retailers to learn
about 'touch' and experience products, while ultimately purchasing
online. Alternatively, consumers may search for product information and
make price comparisons online, placing themselves in a more informed
position when purchasing from traditional outlets.

Online – offline decision – key points

4.28 The literature reviewed suggests that online consumers tend to be

younger, wealthier and better educated than their offline counterparts,
have higher computer literacy, spend more time on their computer and
on the internet, find online shopping easier and more entertaining and are
less fearful of financial loss from online shopping. There is however

36
Brown and Goolsbee (2002)
37
The Economist (May 2004)
38
Zmud et al (2001)
39
Borenstein and Saloner (2001)

23
 some recent evidence of rapid growth in use by older shoppers and in
lower social classes.

4.29 Further, those that actually purchase online (as opposed to using the
Internet purely for search purposes) appear to have been using the
Internet for a longer time, to be more frequent web uses and to spend
more time on the Internet in general. These better informed consumers
can purchase specific products on the Internet without for example
additional bundled research services from traditional suppliers.

4.30 The products most suited to online purchasing seem to be products, like
books and PCs, where most attributes of the products can be
determined online. For lower cost, lower risk items such as CDs, the
convenience offered by the internet retail format may be important. Low
touch products like airline tickets or computer software are products that
favour online services because of the additional importance of shopping
quickly. Overall consumers feel that products with attributes that can be
easily identified through the search process can be better delivered
online and are therefore more frequently purchased online. Products
requiring personal experience process or for which service and delivery
are important factors are viewed as better purchased from offline
sources.

4.31 While price is clearly an important decision factor consumers have been
found willing to trade off convenience and price, and the relative
importance of price has sometimes been found to be ambiguous.
Factors, other than convenience, that lessen the importance of relative
prices particularly in the online context include built or perceived
reputation and trust in the supplier; increased control over purchases and
better information availability about attributes other than price.

4.32 Also the availability of and access to an increased range of products

online are factors creating significant consumer welfare benefits,
possibly greater than the consumer benefit from reduced prices through
competition.

4.33 Online shopping has proved itself as an alternative to traditional retailing

but the two channels can also be complementary. Consumers can take
advantage of each channel’s capacity to convey different types of
information (hard information and prices from online sources, or
experience with products from offline sources) in the buying process.

24
4.34 Frontier Economics expressed concern about complexity of the
information available to consumers but the evidence cited here suggests
that consumers operate flexibly in managing and responding to the range
of information that is available to them.

Search and use of unformation

4.35 Two main approaches have been used to model consumer search in
general. Search models assume that consumers incur a positive cost of
obtaining additional information, such as price quotes. After obtaining
each quote consumers then decide whether or not to incur the cost of
further searching for a potential improvement to the quote. In
information clearing house models, the distinguishing feature is that only
a proportion of consumers choose to gain access to a list of prices
charged by all firms, for example, through a price comparison site and
purchase at the lowest listed price. For other consumers factors such as
loyalty to a trusted retailer may be more important.40

4.36 Most of the models considered have been put forward as possible ways
of explaining continuing price dispersion online. Consideration of
different models has found that reduction in search costs does not
necessarily eliminate price dispersion. This is examined further in section
5.

4.37 These predictions and observations may be explained by the different

characteristics that consumers search for in different products.
Beginning from the premise that consumers assess a range of
characteristics of a product before making the decision whether to
purchase, Bar-Isaac et al have found that if information about product
characteristics becomes more easily available this would have an
unambiguous benefit to consumers.41 However, increased availability of
information may create distortionary incentives for sellers, either in
information provision, or such that firms focus investment on the
characteristics that are now easier to assess. Consumers could then lose
out on benefits from other characteristics that are downgraded. The
overall consumer welfare effect is then ambiguous.

40
For example Baye and Morgan (2001, 2003)
41
Bar-Isaac et al (2005)

25
4.38 The prediction that consumers search for various product attributes
besides price is supported by empirical findings that retailers with the
lowest prices do not make the most sales – there must be other
attributes at play. Brynjolfsson and Smith comment that price dispersion
is lower on the Internet than in conventional outlets. These two
observations in combination could reflect dominance by heavily branded
retailers that are able to charge a premium.42 This could have a negative
impact on consumer welfare, though the authors do not address the
question.

4.39 Tests of how changes in search costs affect price sensitivity have
revealed that lowering the cost of searching for quality information as
well as the cost of searching for prices does not lead to an unambiguous
fall in prices. In fact, the effects of easier quality search may outweigh
those of easier price search in retail markets where quality information is
important. A study of wine purchasing by Ariely and Lynch (2000) found
that increasing access to price information had no clear effect, but
increasing access to quality information decreased price sensitivity. The
main point the authors make is that research should not only look at
search costs for price, but that other product characteristics should also
be taken into account.

4.40 The authors comment that there can also be a time dimension in learning
about product qualities, so that the relative weight of different search
criteria changes through time. One might find that shoppers may be less
price-sensitive when they first shop electronically than when they shop
in brick-and mortar stores. Once real product differences are learned, the
potential of electronic shopping to achieve further differentiation would
diminish while consumers’ ability to track and compare volatile prices
would remain. Thus, one might expect that with the introduction of full-
featured electronic shopping, price sensitivity would initially decrease
and then increase over time compared with prices in brick-and-mortar
retail environments.

4.41 Ellison and Ellison have found the empirical observation that charging a
low price for a low quality product increases online retailers' sales of
medium and high quality products to carry interesting implications about

42
Brynjolfsson and Smith (2000)

26
 consumers' actual search behaviour.43 The reason given for this is that
one cannot ask a search engine to find 'decent quality memory modules
sold with reasonable shipping, warrant and other terms'. Hence, many
consumers use a price comparison site to identify a list of suppliers and
then search within a few of these websites to find other products that
better fit their preferences. If a retailer tries to advertise a decent quality
product on a shopbot with reasonable contractual terms at a fair price, it
will be buried behind dozens of lower price offers on the search engine's
list.

4.42 Other evidence on actual use of search tools and information sources
used suggests that the internet leads to a reduction in the total amount
of time spent on searching. Simulations of behaviour in the presence and
absence of the internet by Lee et al indicate that the presence of the
internet leads to substantial reductions in time with dealer or
manufacturer sources, with information sought from either independent
providers or comparison sites.44

4.43 Since consumers value convenience, perceived reliability and trust in

online purchasing, those factors may also function as search features in
Internet shopping. For example, Smith and Brynjolfsson refer to the
impact of switching costs and online brand loyalty. They found
consumers' past purchase experience had significant predictive power
over future online store choice, with customers willing to pay premium
prices to retailers they had successfully purchased previously from.45
This would imply that past good experiences with particular retailers
reduces the scope of consumers' subsequent searches, perhaps more
than in offline contexts.

Search and use of information – key points

4.44 Various models of consumer search behaviour have been put forward as
part of price discrimination and dispersion investigations. In particular it
is important to recognise that consumers search for various product
attributes besides price.

43
Ellison and Ellison (2004)
44
Lee et al (2002)
45
Smith and Brynjolfsson (2001)

27
4.45 It has been found that if information about product characteristics
becomes more easily available this would have an unambiguous benefit
to consumers. However, increased availability of information may also
lead to distortions in the provision of information. The overall consumer
welfare effect is then ambiguous.

4.46 Lowering the cost of searching for quality information alongside the
provision of price information does not lead to an unambiguous fall in
prices. This is consistent with price not being the only dimension of
competition.

4.47 There could also be a time dimension in learning about product qualities,
so that the relative weight of different search criteria may change
through time. As additional information is provided online price
sensitivity may first decrease and then increase over time compared with
prices in brick-and-mortar retail environments.

4.48 Price search engines are used as initial screening devices to identify a
subset of suppliers but this does not necessarily lead to the lowest
priced products being purchased.

4.49 Because convenience of the process and trust in suppliers is important

online, consumers might limit their search to suppliers that they have
purchased from previously, perhaps more than in an offline context.

4.50 These research findings generally confirm the factors identified by

Frontier Economics as facilitating the growth of online retailing but there
are indications that the interaction between information and consumer
behaviour may change over time.

Are online consumers rational?

4.51 It is very difficult to make robust conclusions about consumer rationality

in general, because of the multitude of factors including company
strategies affecting observed outcomes as well as the definition of
'rationality' itself. For the most part the literature we reviewed focuses
on modelling certain types of behaviour and seeing whether that is a
potential explanation of, for example, observed pricing outcomes, or
investigates aspects of consumer behaviour without commenting on
rationality implications.

28
4.52 One of the factors to consider is the level of information possessed by
consumers, and whether consumers search until obtaining (somehow
defined) 'correct' level of information. For example, a finding that
consumers pay more attention to direct costs than to shipping costs and
evidence of hidden qualities of products may or may not be evidence for
or against rationality, depending on the costs and benefits of obtaining
that additional information. As Gabaix and Laibson point out, some
consumers may rationally choose to deal with companies with high
additional hidden costs.46 Better informed consumers able to avoid the
hidden costs (for example in the form of higher prices at a hotel
restaurant to compensate the hotel for discount rooms) get a cheaper
product at the expense of less informed consumers unaware of the extra
costs.

4.53 Some observed outcomes do, however, have clear rationality

implications, such as lower search costs leading to lower profits —
implying that consumers utilise the search cost savings to find better
prices. Or that the higher the relative price of purchase, the more
consumers will search - the cost of search is matched against the benefit
from potentially material price improvements.47

4.54 Consumers might also behave rationally up to some level of information

acquisition and processing. Investigation by Dellaert et al on how
consumers' shopping decisions alter after disclosure of additional pieces
of information shows that increasing information about current and
future prices improve consumers' shopping performance through time.48
However, additional information also makes it harder for consumers to
'live up' to a theoretical decision making model. Increased information
requires consumers to take into account a greater number of decision
factors so as to fully benefit from this information. As expected, the test
subjects' expenditure on a basket of goods decreased as information
levels increased. However, in moving on to a scenario where more and
more future prices were disclosed to the shoppers, the test subjects’
actual reduction in spending was less than that predicted by the
theoretical behavioural model.

46
Gabaix and Laibson (2005)
47
Bakos (1997) and Janssen et al (2005)
48
Dellaert et al (2005)

29
 Consumer rationality – key points

4.55 It is very difficult to come to conclusions about consumer rationality, due

to difficulty of both definition and measurement given the range of other
factors which can affect observed outcomes. Much of the reviewed
literature did not directly address the question of rationality. There is
some evidence to suggest that when rationality is defined as best
possible use of information at hand, consumers behave rationally up to a
level of information provision, after which they fall short of theoretical
models. The review did not find evidence to suggest that online
consumers are inherently less rational than their offline counterparts.

30
5 COMPANY BEHAVIOUR

5.1 This section considers various aspects of company behaviour in the

context of internet shopping. We draw on the literature to comment on:

• the different business models adopted and their effect on the market

• the way in which internet shopping has affected prices and the
possibility of price discrimination, and

• a range of structural and behavioural features of the market place

including vertical links, collusion and barriers to entry.

Business models

Introduction

5.2 There are a number of different business models which have been
adopted in the development of internet shopping. These include pure
play (firms selling solely online), on-line manifestations of high street
stores (sometimes referred to as clicks and mortar) and auctions. There
is also a range of internet intermediaries such as online referral services
which put consumers who submit online purchase requests in touch with
conventional retailers and price comparison sites. These sites act as
'information intermediaries' between consumers and businesses. The
impact of different approaches to internet shopping on final prices and
interactions between business models has been the subject of research
and media comment and this is reviewed here.

Choice of model

5.3 Choice of business model will depend on a number of factors. Pure play
internet businesses may face lower staff, infrastructure and inventory
costs than offline retailers but incur additional costs in establishing brand
loyalty and retaining customers. For some products, for example,
newspapers and other 'information' goods, delivery costs online may be
reduced, while for 'physical' goods delivery costs may be higher. For
auction sites, which provide a market place but are not responsible for
handling the goods traded on the site, operational costs may be
relatively low. However significant costs may still be incurred in
establishing brand recognition and scale of operation. For intermediaries,

31
 where the information provided is free to users, the challenge is to
identify and lock in revenue streams which will support a viable
business.

Online versus offline

5.4 There have been a number of studies which have attempted to model
the competition between online and conventional retailers and identify
factors influencing the choice of model. These indicate that, on the one
hand, pure play internet providers are able to offer lower prices than
conventional or clicks and mortar operators. However the latter are able
to maintain higher prices in both their online and offline manifestations.

5.5 A study by Friberg in 2000 using data on the sale of books and CDs in
Sweden, estimated that prices were on average 15 per cent cheaper on
the internet but that this saving was partly eroded by transport costs if
only a few items were bought. 49 The model used suggested that firms
which sell both online and in conventional stores have higher online
prices than firms who sell only online. The reason given for this was that
such firms wish to avoid competition between different retail channels
and are wary of 'cannibalization' that is, losing profits offline if they set
prices too low in their online operations.

5.6 A more recent study of share dealing services by Bakos in 2005

examined the impact of e-commerce on sectors where established firms
face competition from internet-based entrants with focussed offerings.50
This study compared incumbent (offline) firms offering a full service of
research and share trade execution with online firms offering just trade
execution. As customer willingness-to-pay declined, the incumbent
found it best to unbundle the research and execution services when
competing with the online entrant. However, Bakos also found that the
differences in commissions charged by offline and online brokerages
could not be fully accounted for by differences in execution qualities.
These continuing differentials indicate that traditional brokers were
successful in differentiating themselves from low-cost rivals.

49
Friberg et al (2000)
50
Bakos et al (2005)

32
5.7 Although this study focused on share brokerage there are similarities
with markets such as estate agency, insurance, home mortgages, travel
services and car retailing. The results from the study may therefore be
applicable in industries where agents act on behalf of clients and where
it is difficult for consumers to assess the quality of a bundled package of
services. In these circumstances agents may be better informed than
consumers and be able to keep prices above the competitive level.

Developments

5.8 There are also indications that business models are subject to continuing
adaptation in the face of changing consumer behaviour The UK's biggest
selling website is Amazon which is essentially a pure play operator,51 but
online sales are now generating substantial revenues for traditional bricks
and mortar retailers. The UK's second biggest retail website is
www.argos.co.uk and department store group John Lewis predicted that
its online sales for 2005 would be over £100m, equivalent to the sales
of one of its largest offline department stores.52

5.9 A survey in The Economist discussed how the internet is changing

consumer behaviour with an increasing number of consumers
researching their purchases online before buying them in conventional
stores.53 According to the article three out of four Americans start
shopping for new cars online, even though most end up buying them
from traditional dealers. The difference is that these consumers arrive at
the showroom with better information about the car and best available
deals. Other industry comment suggest that conventional stores may
move more towards becoming showrooms for goods with actual
purchases being made online.54

5.10 The development of online auctions has opened up new marketing

opportunities. EBay has been one of the fastest growing internet
companies and now has 181 million registered users worldwide.
Although it originated as a site for consumers to sell direct to other

51
Although Amazon does not operate its own bricks and mortar outlets, the site is increasingly
being used by conventional retailers as an additional online platform providing Amazon
customers with direct links to their products.
52
The Guardian, November.2005
53
The Economist (May 2004)
54
IMRG, 2005

33
 consumers, eBay has become increasingly popular as a forum for the
development of online businesses. EBay estimates that there are
currently 68,000 small businesses in the UK which derive a quarter or
more of their income from sales on the site.55

5.11 Auction sites such as eBay are more valuable to both buyers and sellers
the more people participate on both sides of the market. EBay as early
entrant into this form of business has benefited from this network effect
and remains the leading auction site despite the attempts of other
players, including Microsoft to enter the market.56

Business models - key points

5.12 The growth of the internet has created opportunities to develop new
business models which build on the different cost structure of internet
retailing and the new opportunities to make contact and interact with
customers. In the process some totally new streams of business, notably
search engines and price comparison sites, have emerged. As providers
of free information these do not fit easily into the conventional
framework for analysing market interactions on the basis of price.

5.13 In adopting a particular business model a firm will be looking to gain

some advantage over its competitors, to find ways of avoiding the direct
pressures of price competition and, if possible, to lock in any advantages
over the longer term. However such ambitions will be vulnerable to the
responses both of competing firms and of customers. The balance
between these forces will determine the extent to which any one firm is
able to shift the market structure away from the competitive outcome to
its own benefit and the detriment of consumers.

5.14 We have not found evidence to suggest that any one model of internet
retailing has a particular advantage. Pure play internet businesses
operate alongside online manifestations of high street stores and auction
sites. Pure play operators have been able to offer lower prices in many
cases but there is also some evidence of higher prices being maintained
online.

55
The Guardian. February 2006
56
The Economist, May 2004

34
5.15 Operators with both online and offline outlets have generally been able
to maintain higher prices online than their pure play competitors. The
extent to which this reflects added value in the online service or is just a
leveraging of their offline market position, for example, brand loyalty,
has not been established. In general it appears that there is a
considerable degree of interaction between online and offline trading and
that business models are subject to continuous adaptation in the face of
changing business and consumer behaviour.

5.16 Provision of information has developed as a new activity with

information provided free to users and revenue being generated from the
companies whose details have been accessed. Information in this
context has many of the features of a public good – its use by one
person does not reduce the amount available to others. With public
goods there is generally a concern that they may be underprovided if this
is left to market forces. Given the extent of information available on the
internet it is not apparent that this is an immediate issue. However, the
way in which such sites generate revenue is not well documented in the
literature and could be an aspect which merits further research.

Pricing

Introduction

5.17 The impact of internet shopping on pricing has been the focus of much
attention in the literature we have reviewed. This section considers
evidence both on price levels and continuing price differences between
retailers. It also considers factors affecting consumers’ responses to
posted prices and reviews a number of approaches put forward to
explain observed behaviour. Price discrimination is considered as a
separate issue.

Price dispersion

5.18 In the early days of the development of internet commerce some grand
claims were made for the impact of this new approach to trading. In
particular the scope for rapid processing of large volumes of information
and the freedom of access to such information was seen as a sea
change in the operation of markets which would alter the behaviour both
of firms and consumers and lead to increased competition.

35
5.19 As the internet began to develop this vision was enthusiastically adopted
by business leaders.57

The Internet is a nearly perfect market because information is

instantaneous and buyers can compare the offerings of sellers
worldwide. The result is fierce price competition, dwindling
product differentiation, and vanishing brand loyalty. Robert Kuttner
in Business Week, May 11, 1998

… industry titans such as Bill Gates, the boss of Microsoft, regale

the world’s leaders with the promise of 'friction-free capitalism.'
The Economist, May 10, 1997

'All of this brings you closer and closer to the efficient market.'
Robert MacAvoy, President, Eastman Consulting. Business Week,
May 4, 1998

5.20 In this scenario of the development of the new market, prices should be
bid down to the competitive market level. This outcome, known to
economists as Bertrand competition (see box below), is possible even in
oligopolistic markets with a small number of firms.

Bertrand Competition

Bertrand competition is said to occur in a market where there a two or more

firms that sell identical products. Competition is extremely fierce, due to an
absence of barriers to entry and no information asymmetries; so much so that
price is driven to equal average costs (and marginal costs) in both the short and
long run.

Bakos (1991) was one of the first to associate the notion of Bertrand
competition with the sale of goods on the internet. He wrote that 'electronic
marketplaces are likely to move commodity markets closer to the classical ideal
of a Walrasian auctioneer where buyers are costlessly and fully informed about
seller prices… we expect that electronic marketplaces typically will sway
equilibria in commodity markets to favour the buyers, will promote price
competition among sellers, and will reduce sellers' market power.' In theory, it
does seems intuitive that the internet will lead to Bertrand competition due to
low or close to nil costs of setting up a website, the proliferation of information

57
These quotations are cited in Brynjolfsson and Smith (2000)

36
revealing sites and low overheads (fixed costs). Bakos further predicted that the
reduction in customer search costs would allow consumers to easily compare
prices, thereby causing a decrease in switching costs. The subsequent result
would be Bertrand price competition between identical goods such as books and
CDs.

5.21 There is now a substantial body of economic literature which has

examined both the theory and practice of retail pricing on the internet.
There is significant (although not universal) evidence of considerable
dispersion of prices for apparently similar goods or services both
between internet sites and between on- and offline sales outlets. 58 This
is in contrast to the initial expectations for internet pricing. A number of
aspects of pricing have been considered in this literature.

Price levels and price dispersion

5.22 In principle online markets might be expected to be more efficient than

conventional ones as a result of a reduction in information asymmetries
arising from lower search costs. In addition, where entry costs are low
this may limit price premiums sustainable by existing market participants
and favourable cost structures should lead to lower equilibrium prices in
the long run. However the empirical evidence is mixed.

5.23 An early study by Lee in 1998 of prices for used cars sold in the
emerging electronic markets compared with conventional auctions from
1986-1995 found that prices were higher in electronic auctions and had
increased over time.59 Analysis in 1998 by Bailey of prices for matched
set of books, CDs and software sold through conventional and internet
outlets from 1996-1997 found that prices were higher in internet
markets.60 However Brynjolfsson and Smith also analysed a matched set
of books and CDs sold through conventional and internet outlets, for the
period 1998-1999, and found that prices were lower in internet
markets.61

58
See, for example, Smith, Bailey and Brynjolfsson (1999).
59
Lee (1998)
60
Bailey (1998a and 1998b)
61
Brynjolfsson and Smith (2000)

37
5.24 Research by Clemons and others in 1999 using prices quoted by online
travel agents for airline tickets in 1997 found substantial price dispersion
online.62 Subsequent research on a range of goods and services has
continued to show mixed outcomes. A summary of research findings
prepared by Kauffman and Lee is show in the box below. 63

5.25 The studies we have reviewed suggest that price dispersion may occur
for a number of reasons. These include:

• differences between the products being offered on different sites

which are not factored into the analysis

• convenience and shopping experience: for example retailers who

make it easier to find and evaluate products, perhaps through
providing better search tools, may be able to charge a price premium
to time sensitive consumers. One research study found find that the
characteristics of products encountered early in a shopping
experience influenced subsequent purchases made during the same
visit64

• awareness: Many internet retailers aggressively purchase premium

locations on internet portals and spend on advertising through
traditional media. Models simulating consumer behaviour have been
used to demonstrate how asymmetry of information between
consumers and retailers, brand loyalty and network effects can lead
to price dispersion and increased levels of concentration65

• price comparison shopping: People using shopbots do not

necessarily purchase from the retailer with the lowest price. Trust
might be signalled through online communities, links from trusted
sites, unbiased product information and existing conventional world
brand name.

62
Clemons, Hann and Hitt (1999)
63
Kauffman and Lee (2005)
64
Menon and Kahn (1997)
65
Greenwald and Kephart (1999) & Ogus, de la Maza and Yuret (1999)

38
Overview of pricing studies

Authors Data Results

Ancarani and Shankar Prices of books and Highest price dispersion in

(2004) CDs sold in Internet, bricks and clicks retailers and
bricks and mortar, lowest prices in pure Internet
bricks and clicks retailers.

Bailey (1998) Prices of books, CDs, Price dispersion not less online
and software sold and higher prices online
online and offline.

Brynjolfsson and Prices of books and Less price dispersion online

Smith (2000): CDs sold online and and lower prices online.
offline.

Clay et al. (2002a) Prices of books sold Less price dispersion online
online. and that competition led to
lower prices

Clay et al. (2002b) Prices of books sold Timing and direction of price
online. changes correlated across
firms.

Kauffman and Wood Prices of books and Evidence of follow-the-leader

(2005) CDs sold on online. pricing online

Pan et al. (2001) Prices of books, CDs, More price dispersion online
electronics sold
online.

Smith (2001): Prices of books sold More price dispersion in IT

online. related goods and higher
prices for well-known retailers

Tang and Xing (2001) Prices of DVDs sold Less price dispersion online
online and in other and lower prices online

39
 channels.

Arbatskaya and Baye Daily mortgage rates Considerable price dispersion

(2004) posted online. online

Brown and Goolsbee Prices of life Less price dispersion online

(2002) insurance policies. and lower prices online.

Baye and Morgan Prices of consumer Higher price dispersion online.

(2004) electronics sold
online.

Baye et al. (2004) Prices of consumer Higher price dispersion and

electronics sold price levels the smaller the
online. number of firms quoting prices

Carlton and Chevalier Prices of fragrances, High price dispersion online

(2001) DVD players and and less price dispersion
refrigerators. across authorised dealers.

Baylis and Perloff Prices of digital Firms that offer good service
(2002) cameras and charge lower prices and high
scanners sold online. prices firms remain high priced
over long periods.

Lee (1998) Prices of used cars in Higher prices in online

offline and online auctions
auctions.

Morton et al. (2001) Prices of cars sold Less price dispersion online
online and offline. and lower prices online

40
 Price elasticity

5.26 In efficient markets, consumers are more sensitive to small changes in

prices, at least as long as substitute vendors or producers exist. To the
extent that the internet reduces consumers' search or switching costs
this might be expected to result in higher price elasticities. Research
findings again provide mixed results.

5.27 A survey of internet purchases by 25,000 online users carried out by

Goolsbee in late 1997 found that internet purchases were highly
sensitive to local tax rates which could be avoided by shopping online.66
In contrast Degaratu and others study of shopping behaviour for
groceries sold online and in conventional outlets from 1996-97 found
price sensitivity lower online. This may reflect greater sensitivity to
special promotions in-store than online.67 A simulation study by Ariely
and Lynch of behaviour in shopping for wine found that providing better
product information combining price and quality information could reduce
price sensitivity.68 Survey data for travellers, examined by Shankar and
others, showed that prior positive experience with a brand in the
physical world can decrease price sensitivity online.69

Menu costs

5.28 A particular feature of internet markets is a significant reduction in the

cost of introducing price changes. In an electronic market the cost of
changing the 'menu' of prices should be lower than for conventional
retailers since this primarily involves only the cost of a single price
change in a central database. Lower menu costs may be expected to
result in more frequent and smaller changes in internet prices. The
studies of prices for matched set of books, CDs and software sold
through conventional and internet outlets from 1996-1997 referred to in
5.23 above, found that menu costs were lower in internet markets.70
Incremental price changes were significantly smaller than in offline
stores and price changes occurred more frequently.

66
Goolsbee (2000)
67
Degeratu, Rangaswamy and Wu (1999)
68
Ariely and Lynch, (2000)
69
Shankar, Venkatesh and Rangaswamy (1998)
70
Bailey (1998a and 1998b), Brynjolfsson and Smith (2000)

41
 Modelling price dispersion

5.29 In considering the reduced search costs provided by the internet

researchers have identified two paradoxes:

• a price search engine that is so efficient in directing consumers to

the lowest priced retailer may thereby force other retailers out of
business and undermine the rationale for the search engine’s
existence

• if the search engine is efficient and creates a competitive retail

market then retailers may not earn any surplus out of which they are
able to afford to pay the search engine for its services. Furthermore,
consumers will have no incentive to use a search engine because if
they know there is no price dispersion, then they can just go directly
to any retailer.

5.30 These issues have been considered in some detail by Ellison and
Ellison.71 In their view it may be possible for the operators of price
comparison sites to avoid the revenue implications of these paradoxes if
they have a range of pricing instruments. Charging retailers for
advertising on the site and for customer referrals are possibilities. But
the possibility of highly efficient price searching driving retailers out of
business remains.

5.31 One approach to explaining why these paradoxes do not, in practice,

undermine the use of the internet for retail information exchange is to
introduce the idea that there is a combination of information provision
and 'obfuscation' involved in sectors where price search engines play a
dominant role. The authors contend that as search technologies improve
retail firms will have an incentive to put some 'friction' back into the
market by creating an environment in which price search is more difficult
or at least less of a threat to profitability.

5.32 To test their hypotheses on price obfuscation they used data on a

number of small, undifferentiated e-retailers selling computer memory
upgrades, CPUs and other computer parts. This analysis confirmed that:

71
Ellison and Ellison (2004b)

42
 • price search on the internet can dramatically reduce search friction
and lead to extremely elastic demand. They estimate that the firms
faced a demand elasticity of between -25 and -40 for its lowest
quality memory modules

• setting a low price for a low quality (and low margin) product, the so
called 'bait and switch' strategy, has the effect of attracting
potential buyers to the site. This then leads to sales of medium and
high quality products with higher margins. Many consumers use the
search engine to identify lowest cost suppliers and then search
within a few of these websites to find other products that better fit
their preferences on a wider range of product characteristics

• obfuscation strategies, including variations in delivery charges or in

warranty and returns policies, can improves profitability by limiting
the ease with which lowest priced products can be identified.

5.33 The wide range of potential influences on internet pricing and price
dispersion is brought together in research by Kauffman and Lee which
tests a range of propositions (see box below) which might explain pricing
behaviour and considers the empirical evidence in support.72 Using data
from a number of earlier articles, this research finds limited evidence in
support of the price flexibility and consumer demand related
propositions. The propositions that price is related to market structure
and differences in the levels of consumer access to information received
stronger support.

72
Kauffman and Lee (2005)

43
Pricing propositions tested by Kauffman and Lee

• Information quality proposition: if consumers have more information

on the quality of a product sold on the Internet, then Internet-based
sellers will change product prices more frequently, resulting in less
price rigidity.

• Quality Signalling proposition: to signal high quality store images

successfully, higher-quality, higher-priced Internet-based firms
change the prices of products less frequently than lower-quality,
lower prices Internet-based sellers.

• Price Points proposition: Internet-based sellers change their prices

with 9-endings less frequently than those with other price endings
because they have an incentive to make the price endings equal to
$9 or 9c.

• Flexible Price Adjustment proposition: due to very low menu costs

Internet based sellers have the capability to change prices flexibly by
any amount at any time.

• Access-store price staggering proposition: Internet-based sellers

stagger price changes of the same product across firms due to
managerial cost and the interdependence on the actions of their
competitors.

• Product Demand proposition: Internet based sellers have an incentive

to frequently change the prices of highly-demanded products due to
consumers’ higher price sensitivity caused by lower search costs.

• Holiday season delivery lag proposition: during the holiday season,

Internet-based sellers will offer free shipping more often to avoid
antagonising their customers due to delivery lags instead of direct
price changes.

• Internet market concentration proposition: on the Internet, high

industry concentration leads to greater price rigidity due to
consumers' enhanced search capabilities; the more highly
concentrated an industry is, the less rapidly will the industry's firms
adjust prices in response to changes in market conditions.

44
 • Tacit collusion proposition: to avoid intense price competition caused
by search capabilities which both consumers and sellers can use,
Internet-based sellers will tend to tacitly collude with other, leading
to rigid (higher) prices on the internet.

5.34 Kauffman and Lee conclude cautiously that one should probably not
expect less price rigidity in e-commerce. They argue that price rigidity
should be reconsidered in terms of a range of factors including non-price
elements and other competitive considerations including managerial
capabilities, the sophistication of the competition and a firm's chosen
price/quality/service profile in the sector.

Pricing – key points

5.35 Early views that the internet would develop as a 'frictionless' perfectly
competitive market have not been realised. The balance of evidence
suggests that lower prices are available online but that prices offered by
retailers operating both on and offline are higher than those offered by
pure online operators.

5.36 A substantial body of research now exists which demonstrates that

there is a considerable degree of price dispersion for similar goods both
between internet sites and between online and offline sales. A number of
reasons for price dispersion have been considered. These include:

• product differences, for example, quality factors, which are not

factored into the comparison

• convenience and shopping 'experience' aspects for which consumers

may be willing to pay a premium

• consumer awareness may be affected by factors such as advertising

expenditure to encourage brand recognition

• the use of price comparison sites is not necessarily used to identify

the lowest possible price; other 'trust' factors are also important to
consumers.

45
5.37 Price dispersion does not necessarily imply that prices are above the
competitive level. There is no clear indication of the development of
excessive pricing as suggested in the Frontier Economics report. Further
investigation would be necessary to establish whether higher prices
reflected the cost of providing the additional characteristics of the
products or service which consumers valued or whether this was a
reflection of market segmentation designed to reduce competition.

5.38 One feature of the internet is a significant reduction in the cost of

introducing price changes. This should allow retailers to introduce more
frequent and smaller price changes in response to competitors' prices. A
further area for investigation would be the extent to which retailers are
able to maintain any price differentials over a period of time.

5.39 The internet allows consumers to search for product information at a

much reduced cost. There is evidence that this does increase
consumers' sensitivity to prices but, at the same time, this may
encourage firms to adopt strategies which put some 'friction' back into
the search process to prevent prices being driven down below
sustainable levels.

5.40 In general research has found that internet prices are less flexible than
might be expected on the basis of costs and that any assessment needs
to take into account a range of non-price factors which may provide a
rational explanation for price differences and for price rigidity. However
research has also identified market structure and differences in consumer
access to information as relevant factors in explaining price differences.

Price discrimination

5.41 One interpretation of the evidence of the existence of price dispersion is

that this reflects the existence of price discrimination on the part of
internet retailers. Price discrimination which can take various forms (see
box below) exists when two 'similar' products with the same marginal
cost are sold by a firm at different prices.

Types of price discrimination

• First degree (or perfect) price discrimination is where the price is

exactly equal to the maximum the consumer is willing to pay

46
 • Second degree price discrimination involves the establishment of a
pricing structure for a particular good based on the number of units
sold (quantity discounts are a common example), and

• Third degree price discrimination is based on setting different prices

for different groups of consumers.

5.42 A number of characteristics of internet shopping may mean that there is

more potential for online retailers to price discriminate than conventional
retailers. These include the ease of changing prices (low menu costs),
the large amount of information regarding shopping behaviour that online
retailers can collect and the ability to single out individual consumers.
However the literature on internet price discrimination has focused more
on theoretical possibilities, than on actual empirical evidence of price
discrimination being practiced.

5.43 A survey of the recent literature on price discrimination by Armstrong

focused on three aspects of pricing decisions where the development of
the internet might present new or enhanced opportunities for
discrimination:73

• the information about customers available to firms

• the instruments firms can use in the design of their tariffs, and

• the ability of firms to commit to their pricing plans.

5.44 With monopoly supply, an ability to engage in price discrimination will

boost profits unless the firm cannot commit to its pricing policy. With
competition the effects of price discrimination depend on the kinds of
information and/or instruments available to firms. The focus of this
article was on developing the theoretical framework within which price
discrimination could be analysed.

5.45 A simulation experiment by Deck and Wilson in 2005 investigated the

impact of firms tracking customers and offering discriminatory prices

73
Armstrong (2005)

47
 based on search history.74 The authors conducted an experiment using
students who competed as sellers of a fictitious good in a posted offer
market.

5.46 This simulation showed that consumers on average faced the same
prices when sellers had the ability to track customers and price
discriminate as when sellers posted a single price for all buyers.
However, different types of buyers were affected differently by tracking
– informed buyers receive lower prices when sellers could detect buyer
search, whereas uninformed buyers received lower prices when sellers
could not track their behaviour.

5.47 An earlier study by Koch and Cebula used search theory and a survey of
the empirical evidence to analyse the prices paid on the internet, the
quality of goods purchased and the nature of goods received.75

5.48 The authors stated that third degree price discrimination was ubiquitous
on the internet with customers with less elastic demands paying higher
prices. They gave the example of one major US retailer which used the
internet to analyse consumer buying behaviour store by store and
change its inventory and prices accordingly.

5.49 Although the authors state that data mining has enabled e-commerce
firms to accumulate large amounts of consumer information which they
use to engage in price discrimination, they argue that this outcome is
probably not adverse from the standpoint of consumer welfare. This is
because price discrimination increases welfare if total output increases.
Internet retailers who charge all customers the same price may make
society worse off because it may result in some customers not being
served at all.

5.50 Concerns about the erosion of individuals' privacy as a result of internet

transactions have also been linked to the development of price
discrimination.76 Collection of information about individuals and their use
of the internet provides the information that allows sellers to determine
buyers' willingness to pay. It also allows monitoring of usage to ensure
that arbitrage is not used to bypass discriminatory pricing. Price

74
Deck and Wilson (2005)
75
Koch and Cebula (2002)
76
Odlyzko, (2003)

48
 discrimination offers a much higher payoff to sellers than any targeted
marketing campaign particularly where there are one off fixed costs and
low marginal costs. However there are also strong countervailing factors
operating. Consumers have the opportunity and the information to
switch to lower priced suppliers. There is also evidence that people do
not like being subjected to dynamic pricing. This may lead suppliers to
disguise their price discrimination, for example through bundling of
products.

Bundling

5.51 Bundling may provide firms with an alternative to conventional price

discrimination. Price discrimination requires that the seller can accurately
identify consumer valuations and prevent consumers from buying goods
at prices meant for others. Thus, the conventional approach to price
discrimination operates by increasing the number of prices charged to
accommodate the diversity of consumer valuations. In contrast, bundling
reduces the incentive to respond to the diversity of consumer valuations.
Sellers charge only one price without seeking to identify different types
of consumers and do not need to enforce any restrictions on which
prices consumers pay.

5.52 One important effect of the development of the internet has been the
radical reduction in the marginal cost of reproducing and distributing
information goods such as consumer software. This has led to the
development of bundling strategies by internet companies seeking to
make their product more attractive to a wider range of consumers.

5.53 Bundling can create 'economies of aggregation' for information goods if

their marginal costs are very low. A seller typically can extract more
value from each information good when it is part of a bundle than when
it is sold separately. Moreover, at the optimal price, more consumers will
find the bundle worth buying than would have bought the same goods
sold separately.

5.54 Modelling of bundling strategies by Bakos and Brynjolfsson suggests that

these will benefit firms offering larger bundles of goods.77 Large scale
bundlers will be willing to pay more for access to upstream content

77
Bakos and Brynjolfsson, (2000)

49
 because bundling makes demand for their products less price sensitive
and allows them to obtain more profit from new items as they are
added. Because the benefits of aggregation increase with the number of
goods included in the bundle, large bundlers may enjoy a competitive
advantage in purchasing or developing new information goods.

5.55 This analysis suggests that where the marginal cost of the information
good is very low bundling can provide a significant advantage in
competition for upstream information content. Adopting a bundling
strategy may make a firm appear 'tougher' to competitors and potential
market entrants and may allow a firm to dislodge an established
incumbent or deter entry.

5.56 However the development of online trading may also undermine

traditionally bundled products. This can be seen from the research on
competition between online and offline brokerage referred to in
paragraph 5.6 above.

5.57 The results indicate that ecommerce has had a significant impact on the
retail brokerage industry. It triggered market expansion and an industry
transition to a new pricing equilibrium with the development of a wider
range of bundled and unbundled services.

Price discrimination – key points

5.58 The internet allows online retailers to acquire a large amount of

information about the shopping behaviour of individual consumers. This,
coupled with the ease with which online prices can be varied, provides
the opportunity to provide product offerings which are tailored to the
perceived requirements of individual consumers or groups of consumers.
This has led to concern that the internet will offer new opportunities for
price discrimination.

5.59 Much of the literature on this topic has focused on theoretical modelling
of possible price discrimination. There is empirical evidence that third
degree price discrimination (between consumer groups) is widespread
and that consumers with less elastic demand pay higher prices. There is
also research which suggests increased opportunities for bundling of
products as an alternative to direct price discrimination. Successful
bundlers of low cost information goods may gain a competitive
advantage which could deter later entry.

50
5.60 However the impact of price discrimination on consumer welfare is
unclear. If the outcome is an increase in output with more consumers
acquiring goods or services that they value then consumer welfare
should increase. Clear cut anti-competitive effects of price
discrimination, for example predatory price targeting or the earning of
supra-normal profits, identified as possibilities in the Frontier Economics
report, have not been highlighted.

Vertical links

Introduction

5.61 This section considers a limited amount of literature commenting on

vertical integration issues including both integration at the corporate
level and attempts to exert control in other ways along the vertical
supply chain.

Vertical integration

5.62 It has been suggested that in the early stages of electronic commerce,
the firms that dominate the gateways to commerce and channels, in
particular the portals, but also to a lesser degree the shopping bots and
search engines, are able, through the fees they charge, to extract some
of the value created by the positioning they give to competing sites.78

5.63 Vertical integration can offer a firm the possibility of reduced costs and
increased control over profit margins. It may also provide an opportunity
to hedge against risks and uncertainties at different stages in the supply
chain. Vertical integration is particularly a feature of sectors where there
is a requirement for significant levels of long life capital expenditure in
order to maintain a place in the market as is seen, for example, in energy
and chemicals production. To date vertical integration of this sort has
not been a feature of the internet. The investment required to develop an
internet shopping site is not great and the opportunities to make cost
savings through closer control of the supply chain appear limited.

5.64 Development of search engines may require greater up front investment

which, once incurred, may largely be a sunk cost. That will particularly

78
Borenstein and Saloner (2001)

51
 be true of investment to establish brand recognition. However the
opportunity to buy into downstream activities may be limited. Restricting
searches to information owned in-house, for example to particular retail
chains, could seriously reduce the attractions of the search engine.

5.65 One example of vertical integration having some impact on internet

shopping can be seen in the study of the garment industry by Gertner
and Stillman.79 Clothing is one of the leading products on the internet
and it is also a sector in which there is significant variance within the
industry in company organisational form. Some brands are distributed
through vertically integrated specialist retailers and catalogue companies,
whereas other brands are distributed primarily on a non-exclusive basis
through department stores and other non-integrated retailers.

5.66 The authors of the study argue that vertically integrated firms in the
apparel industry, such as Gap, had a greater ability and incentive to
adapt to the internet than non-integrated department stores and vendors.
A number of reasons are given for this. Integrated retailers have lower
transaction costs, in particular they have better control over the costs of
transaction at each stage in the supply chain. They also avoid the
'channel conflict' problem between retailers and brand owners where
brand owners may be unwilling to supply for online sales if this is seen
as a threat to their offline sales in other outlets.

5.67 A sample of 30 firms in the apparel industry was used to investigate

whether vertically integrated speciality retailers tended to start online
sales sooner, even after controlling for pre-existing catalogue operations
and whether the products of vertically integrated speciality retailers and
catalogue companies were more available online than the products of
non-integrated vendors. The empirical study confirmed these
hypotheses.

Vertical restraints

5.68 Manufacturers of certain goods attach particular value to the promotional

effort which traditional retailers provide as part of their in-store service.
For such products customers can free ride off the promotional effort of
the traditional offline retailers acquiring information about products

79
Gertner and Stillman, (2001)

52
 which they then purchase more cheaply on the internet. This can lead to
manufacturers attempting to control the availability and pricing of their
products over the Internet. This is not an issue limited to internet
shopping. It applies to all attempts to sells such products at a discount
to high street prices. However the development of the internet may have
increased consumers' opportunities to obtain access to discounted
prices.

5.69 Empirical investigation by Carlton and Chevalier in 2001 found that

manufacturers of three types of branded goods — fragrances, DVD
players and side-by-side refrigerators — appeared to control the pricing
and availability of their products over the Internet. Each of these
products relies on retail support; fragrances because consumers typically
prefer to try them on prior to purchase, DVD players because of their
complexity; and side-by-side refrigerators because they tend to be high
end refrigerators and consumers generally like to examine the
attractiveness of high-end appliances and inspect their features. In
terminology discussed earlier, all three of the products could be called
'high touch' goods, at least at the time of the study.80

5.70 The study found that fragrance and DVD manufacturers both appeared
to attempt to keep their products from being sold at discount sites, or
attempted to control the extent of price discounting on the Internet. The
two most common restraints used by manufacturers were pricing (with
no discounts allowed) and, less frequently, the restriction of available
supply to only certain internet websites (such as only the manufacturer's
or a selected retailer's website). Manufacturers also can charge high
prices at their own site and those of authorised retailers.

5.71 More recently consumer electronic companies have been accused of just
such a dual pricing strategy – designed to narrow the price differential
between the web and high street – by offering lower discounts to online
traders than their high street rivals.81

5.72 The US Federal Trade Commission (FTC) has looked at similar complaints
in respect of wine, contact lenses and caskets (coffins). Much of the

80
Carlton and Chevalier (2001) — since then DVD players have become much more common
and may not require the same level of retail support
81
Mintel Internet Quarterly, December 2005

53
 FTC's concern has been with State level requirements being used to
restrict the development of e commerce in these products. The FTC has
sought to persuade State legislatures to adopt pro competitive measures
rather than using direct enforcement powers.82

Vertical links– key points

5.73 Vertical integration up or down the supply chain has not been a
significant feature of the development of internet retailing to date. There
have been some examples of manufacturers or retailers seeking to
restrict the ability of internet outlets to offer products at discounted
prices. This practice does not appear to have been widespread but
clearly has the potential to limit online operators' ability to compete, as
was identified in the Frontier Economics report. It is something which
should be kept under review.

Collusion

Introduction

5.74 It has long been recognised that given appropriate market conditions
collusion between businesses either to raise prices or to restrict the
supply of goods or services can result in higher levels of profit and lower
consumer welfare. Explicit collusion, involving direct contact between
companies, is now illegal under both UK and European law although that
in itself does not mean that it has been eliminated. The circumstances
that make explicit collusion attractive to businesses may also mean that
firms have a high degree of awareness of each others activities. They
will have the incentive and the ability to set prices above competitive
levels without fear of those prices being undercut or of losing market
share. This section considers how these considerations operate in the
context of internet shopping.

Tacit collusion

5.75 The possibility of 'tacit collusion' has been the subject of considerable
attention from competition authorities and a number of general
conditions have been identified which make such collusion possible and

82
Ohlhausen (2005)

54
 in the absence of which collusion is unlikely to be sustainable.83 These
include:

• a small number of firms

• regular and repeated contacts between firms

• barriers to entry

• capacity to reach a mutually acceptable equilibrium

• ease of detection of breaking away from the tacit agreement

• ability to enforce agreement.

5.76 A simple flow diagram approach to assessing whether collusion is likely

in a particular industry is set out in the Box below.

83
For a detailed review of the conditions which may support collusion see Study on
Assessment Criteria for Distinguishing Between Competitive and Dominant Oligopolies in
Merger Control. Study for the European Commission, DG Enterprise, Europe Economics
2001.

55
 A step-wise approach
NO
High Concentration/Few Firms Collusion unlikely
YES
NO
Barriers to Entry Collusion unlikely

YES
Repeated Interaction of “Patient Players”* NO In theory, if players do not play repeated games, no cooperative
outcome is possible. In practice, however, it seems unlikely that this
criterion is not met
YES

Stable market conditions, in particular mature market NO High uncertainty, innovation and growth makes stable collusion highly
with low innovation and low uncertainty unlikely.
Further analysis only if other factors strongly suggest there might be
YES collusion after the merger, eg facilitating practices, history of collusion.

Symmetry of firms plus high market transparency NO Different Combinations of

including homogeneous products
Symmetry Market transparency Product homogeneity
High/low High/low High/low
YES

High probability of coordinated behaviour
Check other factors only if they might counteract
tacit collusion, in particular strong buyer power or
maverick firms
All low:
Low probability of tacit collusion in general, but check for division of
markets or customers in differentiated products markets.
Some high/low:
It is not possible to establish a ranking of these criteria. The factors
have to be weighted against each other to assess the probability of
coordinated behaviour after the merger on a case-by-case basis.
Other factors such as multi-market contact or structural links may then
need to be taken into account. These may increase the probability of
collusion.
Ambiguous factors such as excess capacity have to be judged
carefully in the context of particular case.

Internet experience

5.77 Early internet shopping literature predicted that the internet would
facilitate convergence towards perfect competition and collusion would
be impossible (see paragraphs 5.18 -5.20 above). As described above
there is some evidence in certain internet retail sectors to support this
view. However more recent analysis by Campbell and others taking into
account the informational impacts of the internet suggests that collusion
may actually be easier on the internet.84

5.78 The relationship between online retailers and search portals is less
discussed. The literature tends to refer to price search engines (or
shopbots) when discussing search in relation to internet shopping. The
impact of the conventional search engines (Google, Yahoo, etc.) is not

84
Campbell et al (2005)

56
 generally considered. The December 2005 Mintel report does note that
Yahoo! Recently introduced a programme of paid for inclusion, but
quickly claimed it was committed to maintaining an 'iron wall' between
the process of paying to be included in the index and the algorithmic
decision about how high to rank a particular page on any given search
query.

5.79 In considering the possibility of collusion between internet retailers the

focus has been on the increased provision of information about retail
prices both through company internet sites and through price comparison
sites. The counterpart of reduced search costs for consumers is
increased visibility of pricing behaviour between firms. This provides
essential material for any tacit collusion and also allows firms to identify
any players that are deviating from the 'collusive' price level.

5.80 The research by Campbell and others uses a modelling approach to

examine the impact of reduced search costs on the prices of commodity
products in electronic marketplaces. The authors show that less costly
consumer search can facilitate firms' ability to collude leading to higher
prices even with no monitoring of each others prices by sellers. The
technology that allows consumers to search for the lowest prices also
allows firms to monitor each others prices more easily. Firms can more
easily detect cheating on a collusive price arrangement, allowing even
greater scope for collusion. The authors suggest that in the absence of
an appropriate legal and regulatory remedy to deter such collusion, at
least some of the anticipated gains in market efficiency from electronic
markets may be difficult to realise.

5.81 An earlier study by Kauffman and Wood sought to test the validity of
four hypotheses about collusion on the internet (see Box).85 The model
suggests how electronic commerce technology enables firms to be
extremely responsive to pricing changes for products. This
responsiveness ultimately enables firms to collude tacitly with each other
to help ensure higher profits for all.

85
Kauffman and Wood, (2000a)

57
Collusion hypotheses

• Modified tit-for-tat: internet-based sellers will tend to react

collusively if the competitors that they are responding to tend to act
collusively. Conversely, internet-based sellers will tend to act
competitively (that is, non collusively) if competing internet-based
sellers that they are responding to refuse to tacitly collude. A
corollary of this is that levels of collusion and competition will vary
among different industries for which internet-based selling is
observed.

• Asymmetric competition hypothesis: the more market power on

internet-based seller has in relation to another internet based seller,
the more likely that the former will respond with a competitive price.

• Competitor response time hypothesis: the less time, on average, that

a firm takes to respond to its competitors, the more likely its
competitors will tend to act collusively toward that firm. Conversely,
the more time, on average, that a competitor takes to respond to its
competitors, the more likely its competitors will tend to act
competitively toward that firm.

• Firm response time hypothesis: the more quickly a firm responds to

its competitors, the more likely that firm will tend to act
competitively.

5.82 Kauffman and Wood carried out an econometric analysis of data on

online sales of books and music CDs in 2000. The results indicate that:

• an increase in a competitor's response causes a firm to act more

competitively. Firms tend to collude with a colluder and compete
with a competitor

• the more market power a firm has the more likely it is to act
collusively. The actions of smaller firms have little impact on the
sales and revenue of market leaders

• the ability of competitors to respond rapidly is more likely to

encourage collusion than competition.

58
5.83 This paper shows how the same firms can act differently in different
environments, and that the competitive choices of the market leaders in
an industry can determine the nature of competitive interactions
throughout the industry. It is this interaction that decides whether the
environment is collusive or competitive. The econometric estimates of
collusion and competition show that firms are influenced by the actions
of the competitor to whom the firm is responding, by the market power
of that firm relative to the market power of the competitor, and by
competitors’ ability to immediately respond. They also show that a firm
may choose to compete intensely rather than collude to drive current
and future competitors from the market, but this strategy is deemed
risky.

Collusion – key points

5.84 Explicit or tacit collusion between firms will generally only occur if
certain market conditions are met. Regular and repeated contacts
between firms, ready availability of pricing information and the ability of
firms to respond rapidly to price changes are all necessary (although not
necessarily sufficient) conditions for collusion to be feasible and
sustainable.

5.85 The increased provision of information about retail prices both through
company sites and through price comparison sites provides essential
material for collusion and reduces the cost to forms of acting in this
way. This ease of information flow also allows firms to detect any
attempts to cheat on the collusive price level. The low cost of changing
prices allows firms to respond quickly to any cheating and 'punish' such
deviation.

5.86 Research into alternative explanations of internet firm behaviour

suggests that the ability of competitors to respond quickly to any price
change is a significant factor in encouraging tacit collusion.

5.87 This is in line with concerns raised in the Frontier Economics report.
However there are also other features of market structure which are
generally considered as necessary if collusion is to be sustainable. These
include a small number of players and significant barriers to entry.
Further research into the potential or presence of collusion in internet
shopping would need to consider the full range of relevant factors.

59
Barriers to entry

Intellectual Property Rights

5.88 One might expect that IPR issues may be significant for the development
of Internet shopping either in respect of replication of products, or of
proprietary technology. For example, the fact that ebay.com owns
PayPal and has recently acquired Skype (both of which could be
considered as part of the transaction infrastructure of the internet) might
pose competitive issues for internet shopping through network effects or
the level of licensing fees for competitors. The literature search did not,
however, find analysis of these types of issues for the review.

5.89 Most fundamentally from the point of view of intellectual property rights
on products, the Internet provides a means of perfect duplication and
easy distribution of works such as texts, pictures, audio-visual material,
and other authorship for which copyright law provides certain exclusive
rights to owners. This would be a question of upholding the existing
copyright laws — fundamental patent law norms are not subject to
challenge by the Internet.86 Copyright protection has been used as a
means of challenging the sale of counterfeit goods on auction sites.87

Network effects and returns to scale

5.90 The possibility that online marketplaces might develop as natural

monopolies and might develop as the preserve of a dominant provider
was raised in the Frontier Economics report in 2000. The concern was
that some markets might be increasingly effective the more participants
that could be attracted. At some 'tipping' point the scale of an operation
could make it difficult for the incumbent to be challenged by a new
entrant.

5.91 While the possibility of network effects of this sort is acknowledged in

the literature, particularly in relation to the development of auction based
markets and the success of eBay, we have not identified any analysis of
the operation of network effects in the development of internet
shopping.

86
Meyer (1998)
87
MSNBC, September 2004

60
 Other barriers to entry

5.92 Section 4 discussed how reputation is a significant factor when

consumers decide which online seller to purchase from, with brand
recognition mattering when there is no personal contact. Successfully
establishing brand loyalty may also be important in retaining online
customers. This is likely to lead to aggressive advertising and promotions
to establish reputation and charge a higher price.88 Successful early
entrants to internet shopping may then have an advantage over later
entrants.

5.93 It may be that potential for barriers created by consumer attitudes about
internet purchasing in general will lessen over time as consumers
become more educated, and the user demographic of internet shopping
becomes more and more mainstream.

5.94 The internet has opened up new opportunities for bundling of products,
particularly information goods. It is possible that early success in
assembling attractive product bundles may provide a cost advantage
which is a deterrent to later entrants.

Regulation

5.95 The European Commission has introduced a number of Directives

applicable to e- commerce. These include Directives on distance selling,
data protection and electronic signatures. The Electronic Commerce
Directive 2000 built on these earlier initiatives to provide harmonised
rules but only in those areas where intervention is strictly necessary to
ensure the free operation of electronic services between Member States.
The main objective of the Directive is to bolster the single market by
ensuring the free movement of so-called 'information society services'
(ISS) across the EEA and to encourage the greater use of e-commerce by
clarifying the rights and obligations of businesses and consumers. This
Directive applies to a wide range of internet services including internet
shopping.

5.96 The Electronic Commerce (EC Directive) Regulations 2002 which

implemented this Directive in the UK covers the issues of applicable law,

88
Wiseman (2000)

61
 provision of information by internet operators, provisions governing
online contracts, extent of and limitations on liability. The Directive and
its implementation have been criticised for leaving ambiguities in
definitions which may lead to inconsistencies between Member States
and encourage service providers to seek out locations with the least
restrictive regulatory environment. 89 This high level regulatory
framework is clearly relevant to the issues of consumer trust and
security identified in Section 4.

Barriers to entry – key points

5.97 The investment required to establish brand recognition and consumer

trust may be higher for online than for offline trading. This may provide a
barrier to entry for new entrants facing established incumbents. A
regulatory framework which increases consumer confidence in online
shopping may help to counteract this concern.

5.98 Barriers resulting from lack of access to relevant intellectual property or

from network effects favouring an incumbent have not been highlighted
in the literature.

89
Turner and Traynor (2002)

62
6 CONCLUSIONS

6.1 The development of internet shopping has been the subject of a growing
body of economic research. The main focus has been on the responses
of consumers and businesses to the opportunities offered by the internet
with particular attention to effects on prices and to interactions between
online and offline retailing.

Business models

6.2 The growth of the internet has created opportunities to develop new
ways of operating retail businesses which build on the different cost
structures and consumer interactions which are available. These include
new streams of business like search engines and price comparison sites.

6.3 We have not found evidence to suggest that any one model of internet
retailing has a particular advantage. Pure play operators exist alongside
online outlets of high street stores and auction sites. Pure play sites have
been able to offer lower prices but there is also evidence of higher prices
being maintained online. In general operators with both online and offline
outlets have been able to maintain higher prices on line than their pure
play competitors. This may be a reflection of consumer preferences or of
brand loyalty. For the most part there is considerable interaction
between online and offline trading and business models are subject to
continuous adaptation.

6.4 Provision of information on the internet, free to users, is a relatively new

commercial activity. The way in which revenue is generated by these
information sites is not well documented and could be the subject of
further investigation.

Prices and competition

6.5 There are indications that the internet has provided benefits to
consumers in the form of lower prices, particularly where well defined
standard products such as books and CDs are involved. There are also
indications that internet retailers are capable of offering a wider range of
particular products than is normally available from traditional retailers.
This, too, is a benefit to consumers.

63
6.6 However early predictions that the internet would provide a 'frictionless'
and highly competitive market have not been borne out by this research.
There is a substantial body of evidence showing the continued existence
of a range of prices for similar products. This price dispersion has been
observed both between online and offline outlets and between online
retailers.

6.7 Various explanations have been advanced to explain the continuing

existence of price dispersion. The evidence on consumer attitudes to
internet shopping suggests that a variety of factors other than price are
important in deciding whether to shop on-or offline. These include
product quality information and the types of service being offered in
alternative shopping channels. Consumers are prepared to make a trade
off between price and other factors such as convenience, site or retailer
reputation, detail of information and trustworthiness.

6.8 These factors may provide a good explanation for observed price
differences but there is also some evidence to suggest that price
differences can be linked to levels of market concentration. Further
investigation would be necessary to establish whether price difference
reflect the cost of providing the additional characteristics valued by
consumers or whether this is the result of market segmentation designed
to reduce competition. A particular aspect which could be investigated is
whether price differentials are sustained over a significant period of time.

6.9 A further consideration is that the characteristics that consumers look

for if they are to feel confident in shopping online, for example related to
trust, security and convenience, may require significant up-front
investment by internet retailers. This may provide a basis for market
segmentation and first mover advantage which could deter subsequent
entry.

Availability of information

6.10 The internet provides consumers with access to substantially more

information than was previously available and this is generally beneficial.
This is accessible in a variety of ways, for example, from retailers own
sites, search engines and price comparison sites. Price comparison sites
are widely used by consumers in searching for goods but this does not
necessarily lead to the lowest priced products being purchased.

64
6.11 There is evidence to suggest that internet retailers may be able to
manage the information flows on their sites. The use of low priced offers
as a means of attracting potential buyers to a site with the objective of
selling higher value products is one example. Consumers have a limited
appetite for acquiring additional pricing information and may also limit
their purchasing to trusted suppliers. As a result consumers do not
extract the full benefit of lower prices.

6.12 In practice consumers appear to adopt a flexible approach to sourcing

information. The products that consumers are most willing to buy on line
are those with well defined attributes which can easily be researched
online and which do not require direct contact. Books, CDs and travel
tickets all fall into this category. Where a wider range of such products
can be made available online for example, a longer book catalogue or
wine list, this is of particular value. Consumers prefer offline retailing for
products requiring personal experience or where service and delivery are
important.

6.13 Depending on the circumstances and the products involved consumers

may see online and offline retail outlets either as substitutes or as
complements. The use of traditional retail outlets to acquire information
about products which are then purchased online at lower prices can raise
free-rider concerns which in the extreme may lead to attempts to restrict
online retailers' access to products. This is not an issue which is unique
to internet shopping and there is only a limited amount of evidence of it
occurring in practice. However it has the potential to restrict competition
and is an aspect which should be kept under review.

Price discrimination and collusion

6.14 The internet provides new opportunities to acquire information about

consumers' shopping preferences. This coupled to the ease with which
prices can be varied provides internet retailers with new opportunities to
tailor their products to individuals' preferences and to apply differential
prices which increase business profits and reduce consumer benefits.

6.15 Much of the discussion of this issue has been based around theoretical
modelling although there is some evidence that retailers are able to
charge higher prices to customers who are less sensitive to price
changes. Differences in prices also need to take into consideration the

65
 points discussed above concerning non-price characteristics. Product
bundling may also be used as an alternative to price discrimination.

6.16 The effect of price discrimination, if it could be proved, on consumer

welfare is not clear cut. It is possible for price discrimination to result in
an increase in welfare.

6.17 There has also been discussion about the potential for the internet to
lead to an increase in actual or tacit collusion between retailers. The
provision of information on prices which, in the first instance, is
beneficial to consumers also provides essential information on which
collusion can be based and may also make it difficult for an individual
competitor to gain from offering lower prices.

6.18 At the same time the flow of information is only one of a number of
features which would generally need to be present if collusion is to
succeed. These other aspects, which include there being only a small
number of players, would need to be taken into account in any further
investigation.

Market definition

6.19 Any assessment of the impact of internet shopping on competition and

on consumer welfare would need to start with an assessment of the
relevant market as set out in OFT's Guidelines. Market definition has not
been addressed directly in the literature reviewed although the range of
studies on pricing and price dispersion are relevant

6.20 The rapid growth of internet shopping has largely been at the expense of
traditional retailing but the internet still only accounts for a small, if
growing, proportion of retail sales. Some products, particularly those
with characteristics which can be fully identified online and/or are
relatively low priced, are more suited to internet trading than others.

6.21 Lower prices have been an important but not the only factor in the
growth of internet sales and there appear to be opportunities for price
differentials to be maintained. This reflects some form of product
differentiation even with products such as books and CDs which are
particularly suited to internet trading.

66
6.22 There is no indication from these findings that there is any requirement
to develop new approaches to market definition in considering the
operation of competition. In general it appears that the internet trading
forms part of the wider retail sector. This would normally be considered
on a product by product basis through an examination of price
sensitivity. While there are products which appear more suited to
internet trading than others we have not identified areas where the
internet should be regarded as constituting a separate market.

Areas for further work

6.23 Internet shopping continues to grow rapidly and there is evidence that
this is beneficial to consumer in terms of lower prices, increased access
to information and increased choice. However the continued existence of
price dispersion, the way firms may be able to influence information
flows and the potential for price discrimination and tacit collusion have
all been identified as issues which should be kept under review. Targeted
studies of individual products and of the persistence of price differentials
would provide a focus for monitoring developments.

6.24 There are certain aspects of internet retailing which have not been the
subject of the research covered in this review. Concerns have been
expressed in the past that network effects could result in dominant
players and barriers to entry. This has not emerged from the literature as
an issue in the development of internet shopping to date although the
related issue of potentially high start up costs has been highlighted as a
possible barrier. Network effects are likely to be particularly important in
the development of internet auction sites. This is an area where further
research could be considered to establish if competition is likely to be
restricted.

6.25 Access to information is one of the defining benefits of the internet but
little attention has been given to the way in which search engines and
other information sites manage and finance that information. This too
could be the subject of further research to establish whether the benefits
to consumers from information flows is in any way being restricted.

67
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Chakravorti, S. and Roson, R
Chen, P. and Hitt, L.
Chen, P. and Hitt, L.
Chen, P. and Hitt, L.
Chen, P. and Hitt, L.
Choi, S., Stahl, D., and A.
Whinston
Chun, S. and Kim, J.
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Free Riding and Sales Strategies for the Internet Journal of Industrial Economics, XLIX, pp. 441-462, 2001
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The Impact of Internet on Market Structure IESE Business School Research Papers D/467 2002
The Economics of the Internet: Infrastructure and Oxford Review of Economic Policy, Vol.17, No.2, 2001
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Nominal rigidities without literal menu costs: Economics Letters 86 pp. 187–191, 2005
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Platform Competition in Two-Sided Markets: The Federal Reserve Bank of Chicago in its series Working Paper Series
case of payment networks with number WP-04-09, 2004
A Model of Price Dispersion in Internet-Enabled Mimeo 2004
Markets
Measuring switching costs and their determinants in Information Systems Research, 13(3) pp. 255-276, 2002
internet enabled businesses: a study of the online
brokerage industry.
Competition and Switching Cost in On-Line Journal of Product and Brand Management, Vol. 14:129-136,
Brokerage. 2005.
Information Technology and Switching Costs Handbook on Economics and Information Systems, forthcoming
The Economics of Electronic Commerce. The Economics of Electronic Commerce, MacMillan Publishing
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Analysis of price competition and strategic International Review of Economics and Finance 14 pp. 455–468,
implications for heterogeneous market structure 2005
Internet Cost Allocation and Pricing Internet economics pp. 215 – 252, 1997
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Clemons, E., Hann, I. and Hitt,
L.
Coates, V.
Cristina, M. and Pereira, P.
Danaher, P., Wilson, I. and
Davis, R.
Daripa, A. and Kapur, S.
Deck, C. and Wilson, B.
Deck, C. and Wilson, B.
Degeratu, A., Rangaswamy, A.
and Wub, J.
Degeratu, A., Rangaswamy, A.
and Wu, J.
Dellaert, B., Golounov, V. and
Prabhu, J.
Eastin, M
Elberse, A., Barwise, P. and
Hammond, K.
Elliot, S. and Fowell, S.
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offerings.
Buying and Selling on the Internet: Retail Electronic Managerial and Decision Economics, 1999
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Who Benefits from Electronic Commerce? Contemporary Economic Policy, , Vol. 20 Issue 1, pp. 25,
Jan2002
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Pricing on the Internet Oxford Review of Economic Policy 17(2), pp. 202-216, 2001
Tracking Customer Search to Price Discriminate Economic Inquiry Advance Access published November 16, 2005
The Effectiveness of Low Price Matching in Electronic Commerce Research, 2(4), November, 2002,
Mitigating the Competitive Pressure of Low Friction
Electronic Markets
Consumer choice behavior in online and traditional Intern. J. of Research in Marketing 17 pp. 55–78, 2000
supermarkets: The effects of brand name, price, and
other search attributes
Consumer choice behavior in online and regular eBusiness Research Center, Pennsylvania State University 03-99
stores: the effects of brand name, price, and other
search attributes.
The Impact of Price Disclosure on Dynamic Shopping Marketing Letters, 16, (1), pp. 37-52, 2005
Decisions
Diffusion of E-commerce: An analysis of the adoption Telematics and Informatics, Volume 19 , Issue 3, August 2002
of four E-commerce activities
The impact of the internet on horizontal and vertical Advances in Applied Microeconomics, 11, 2002
competition: Market efficiency and value chain
reconfiguration
Expectations versus reality: a snapshot of consumer International Journal of Information Management 20 pp. 323-336,
experiences with Internet retailing 2000
Bounded Rationality in Industrial Organization Mimeo 2005
Author
Ellison, G. and Fisher Ellison, S.
Ellison, G. and Fisher Ellison, S.
Ellison, G. and Fisher Ellison, S.
Ellison, G. and Fudenberg, D.
Ellison, G. and Fudenberg, D.
Ellison, Glenn; Ellison, Sara
Fisher.
Eric B. Budish and Lisa N.
Takeyama
Fairlie, R.
Farrell, J. and Klemperer, P.
Farrell, J. and Weiser, P.
Fay, S., J. MacKie-Mason.
Fernández, Z. and Nieto, M.J.
Forsythe, Sandra M. - Shi, Bo
Fraumeni, Barbara M.
Freund, C. and Weinhold, D.
Friberg, R., Mattias, G. and
Sandström, M.
Title
Search, Obfuscation, and Price Elasticities on the
Internet
Tax Sensitivity and Home State Preferences in
Internet Purchasing
Industrial Organization: Lessons from the Internet
Knife-Edge or Plateau: When do Market Models Tip?
A Model of Add-on Pricing
Lessons About Markets from the Internet.
Buy prices in online auctions: irrationality on the
internet?
Race and the Digital Divide
Coordination and Lock-In: Competition
Switching Costs and Network effects
Modularity, Vertical Integration, and Open Access
Policies: Towards A Convergence of Antitrust and
Regulation in The Internet Age
Competition between firms that bundle information
goods.
The Internet: Strategy and Boundaries of the Firm
Consumer patronage and risk perceptions in Internet
shopping
E-Commerce: Measurement and Measurement Issues
The effect of the Internet on international trade
Pricing Strategies in E-Commerce: Bricks vs. Clicks
Publication and Date
NBER Working Papers with number 10570, 2004
Second Conference on "The Economics of the Software and
Internet Industries", Toulouse, France, January 17-18, 2003.
Mimeo 2004
Quarterly Journal of Economics 118:4, pp. 1249-1278, 2003
Quarterly Journal of Economics, 120, 2005
Journal of Economic Perspectives Volume 19, Number 2, Spring
2005, pp. 139-158(20), 2005
Economics Letters Volume 72, Issue 3 , pp. 325-333, September
2001
Contributions to Economic Analysis & Policy: Vol. 3: No. 1, Article
15, 2004
with In Handbook of Industrial Organisation Vol. 3 (eds. M. Armstrong
and R. Porter), Amsterdam: North-Holland, 2005 (
Berkeley Working Paper No. E02-325, 2003
Working Paper, University of Florida, Gainesville, 2003
Universidad Carlos III de Madrid, Working Paper 05-01 (01), 2005
Journal of Business Research Volume 56, Issue 11, pp. 867-875,
November 2003
American Economic Review. Volume 91 Issue: 2 pp. 318-322,
2001
Journal of International Economics 62 pp. 171– 189, 2004
The Research Institute of Industrial Economics. Working Paper No.
559, 2000
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Frontier Economics
Füstös, János T.; lópez, Larry M
Gabaix, X. and Laibson, D.
Gabaix, X. and Laibson, D.
Gandal, N.
Gans, J. and King, S.
Garicano, L. and Kaplan, S.
Gatti, R and Kattuman, P
Gaudeul, A. and Jullien, B.
Gertner, R. and Stillman, R.
Ghose, A., Mukhopadhyay, T.
and Rajan, U.
Goolsbee, A and Chevalier, J.
Goolsbee, A.
Goolsbee, A.
Graham, A.
Granados, N., A.R. Gupta, and
76
Title
E-Commerce and its Implications for Competition
Policy
Legal Aspects of E-Commerce Practices in the US
and the EU
Shrouded Attributes, Consumer Myopia, and
Information Suppression in Competitive Markets
Competition and Consumer Confusion
The dynamics of competition in the internet search
engine market
The Neutrality of Interchange Fees in Payment
Systems
The Effects of Business-to-Business E-Commerce on
Transaction Costs
Online Price Dispersion within and between Several
European Countries
E-commerce, two-sided markets and info-mediation
Vertical Integration and Internet Strategies in the
Apparel Industry
Strategic Benefits of Referral Services
Measuring Prices and Price Competition: Amazon and
Barnes and Noble
Competition in the Computer Industry: Online versus
Retail
In a World without Borders: The Impact of Taxes on
Internet Commerce
The Assessment: Economics of the Internet
The Impact of IT on Market Information and
Publication and Date
OFT Discussion Paper August 2000
Competitiveness Review Issue: Winter-Fall 2004
NBER Working Papers No. 11755, 2005
Econometric Society 2004 North American Summer Meetings with
number 663.
International Journal of Industrial Organisation 19, pp. 1103–
1117, 2001
Topics in Economic Analysis & Policy, 3 (2003)
Journal of Industrial Economics, Vol XLIX, No.4, Dec. 2001
Cambridge Working Papers in Economics / Department of Applied
Economics, University of Cambridge 7, 2003
Economics Working Paper Archive EconWPA in its series Industrial
Organization with number 0503014, 2005
Journal of Industrial Economics, Vol. XLIX, No.4, 2001
Review of Marketing Science Working Papers, Vol.2, Issue 2 2002
NBER Working Papers No. 9085, 2002
Journal of Industrial Economics, Vol. XLIX, Dec. 2001
Quarterly Journal of Economics, Vol. 115, n. 2, pp 561-576,
2000
Oxf Rev Econ Policy 17 pp. 145-158, 2001
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He, C. Competition in an Internet Mall: A Strategic Analysis Mimeo 2001

Heidhues, P. and Koszegi, B.
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Hong, W., Thong, J. and Tam,
K.
Hörnle, Julia
Huang, J., C. Chang, and C.Y.
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Iyer, G. and Pazgal, A.
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Modeling the customer in electronic commerce Applied Ergonomics 31 pp. 609 -619, 2000
Productivity, Business Profitability, and Consumer MIS Quarterly, June, 1996
Surplus: Three Different Measures of Information
Technology Value
Designing product listing pages on e-commerce Int. J. Human-Computer Studies 61 pp. 481–503, 2004
websites: an examination of presentation mode and
information format
E-commerce and Competition Computer Law & Security Report Vol. 18 no. 3 2002
Perceived fairness of pricing on the Internet Journal of Economic Psychology 26 pp. 343–361, 2005
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Jansse, M. and van der Noll, R.
Janssen, M, Moraga-Gonzalez,
J and Wildenbeest, M.
Janssen, M. and Moraga, J.
Jensen, T., Kees, J., Burton, S.
and Turnipseed, F.
Kauffman, R and Lee, D.
Kauffman, R. and Lee, D.
Kauffman, R. and Walden, E.
Kauffman, R. and Wood, C.
Kauffman, R. and Wood, C.
Keen, C., Wetzelsb, M., de
Ruyterc, K. and Feinberg, R.
Keeney, R.
Kephart, J. and Greenwald, A.
Kettinger, W. and Hackbarth, G.
Kiesler, S., Kraut, R.,
Cummings, J., Boneva, B.,
Helgeson, V. and Crawford, A.
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Title
Internet Retailing as a Marketing Strategy
Consumer Search and Pricing Behaviour in Internet
Markets
Pricing, Consumer Search and the Size of Internet
Markets
Advertised reference prices in an Internet
environment: Effects on consumer price perceptions
and channel search intentions
Price Rigidity on the Internet: New Evidence from the
Bookselling Industry
Should We Expect Less Price Rigidity in the Digital
Economy?
Economics and Electronic Commerce: Survey and
Research Directions
Follow the Leader: Price Change Timing and Strategic
Pricing in E-Commerce
Analyzing Competition and Collusion Strategies in
electronic marketplaces with information asymmetry
E-tailers versus retailers: Which factors determine
consumer preferences?
The Value of Internet Commerce to the Consumer
When Bots Collide
Integration of Electronic Commerce Networks into
the Sales Processes of Small Firms
Internet Evolution and Social Impact
Deriving a diffusion framework and research agenda
for web-based shopping systems
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Tinbergen Institute Discussion Paper TI 2005-038/1
Mimeo 2005
Tinbergen Institute Discussion Paper 2000-0042.
Journal of Interactive Marketing, Volume 17, Issue 2 , pp. 20 –
33, 2003
ICIS 2004: 843-848
Proceedings of the 37th Hawaii International Conference on
System Sciences, Kona, HI, IEEE Computer Society Press, Los
Alamitos, CA, January 5-8., 2004
International Journal of Economic Commerce, 5, 4 pp. 4-115,
2001
Managerial and Decision Economics, forthcoming
University of Minnesota Working Paper 00-21
Journal of Business Research 57 pp. 685– 695, 2004
Marketing Science, Vol. 45, No.4, April 1999
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Kocas, C. and Kiyak, T.
Koch, J. and Cebula, R.
Koyuncu, C. and Bhattacharya,
G.
Krosch, L. and Crisp, A.
Kuksov, D.
Kurzweil, R.
Kuttner, R.
Lal, R. and Sarvary, N.
Latcovich, S. and Smith, H.
Lee, H., Chang, C., Young, H.
and Lee, R.
Lee, H.G.
Lee, M., Rachtford, B. and
Talukdar, D.
Lee, Z. and Gosain, S.
Levin, A., Levin, I. and Weller,
J.
Lewis, J.
Li, H and Sherman, R.
Title
Theory and evidence on pricing by asymmetric
oligopolies
Price, Quality and Service on the Internet: Sense and
Nonsense
The impacts of quickness, price, payment risk, and
delivery issues on on-line shopping
The Electronic Commerce (EC) Regulations 2002
Buyer Search Costs and Endogenous Product Design
IT Doesn't Scatter
The Net: A Market Too Perfect for Profit?
When and How is Internet Likely to Decrease Price
Competition
Pricing, Sunk Costs, and Market Structure Online:
Evidence from Book Retailing
Is the internet making retail transactions more
efficient? - Comparison of online and offline CD retail
markets
Do Electronic Marketplaces Lower the Price of
Goods?
The Impact of the Internet on Information Search for
Automobiles
Price comparison for music CDs in electronic and
brick-and-mortar markets: Pricing strategies in
emergent electronic commerce
A Multi-attribute Analysis of Preferences for Online
and Offline Shopping: Differences across products,
consumers and shopping stages
Aux armes, citoyens: Cyber security and regulation in
the United States
What would Hotelling say about E-Commerce?
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2006
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Journal of Socio-Economics, Volume 33, Issue 2, pp. 241-251,
April 2004
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Harvard Business Review, Vol. 79 Issue 2, pp. 122-127, 2001
Business Week, 11 May 1998
Marketing Science, vol. 18, no. 4, pp. 485 - 503, 1999.
Oxford Rev. Econ. Policy; 17, pp. 265 – 281, Summer 2001
Electronic Commerce Research and Applications, Volume 2,
Number 3, Autumn 2003
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Liao, Z. and Cheung, M.
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Lee, M.
Litan, R. and Rivlin, A.
Lohse, G., Bellman, S. and
Johnson, E.
Lucking-Reiley, D.
Lynch, P and Beck, P.
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Internet-based e-shopping and consumer attitudes: Information & Management 38 pp. 299-306, 2001
An empirical study
Is eCommerce boundary-less? Effects of Journal of International Business Studies 35, pp. 545–559, 2004
individualism-collectivism and uncertainty avoidance
on Internet shopping
Projecting the Economic Impact of the Internet. The American Economic Review, Vol. 91, No. 2, 2001
Consumer buying behaviour on the Internet: findings Journal of Interactive Marketing, Vol.14, No.1., pp. 15-29, 2000.
from panel data
Auctions on the Internet: What's Being Auctioned, Journal of Industrial Economics. 48:3, pp. 227-252, 2000
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Profiles of Internet Buyers in 20 Countries: Evidence Journal of International Business Studies, 32, 4, pp. 725-748,
for Region-specific strategies 2001

Maier, P. A 'Global Village' without borders? International price DNB Working Paper, No.44 May 2005
differentials at eBay
Malueg, D. and Schwartz, M. Interconnection Incentives of a Large Network Georgetown University Working Paper 01-05, 2001
Marschak, T. Organisation Structure Handbook on Economics and Information Systems, forthcoming,
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Mason, R. Simple competitive Internet pricing European Economic Review 44 pp. 1045-1056, 2000
McNealy, S. Intellectual Property Rights on the Internet Computer Law & Security Report Vol. 14 no. 1 1998
Mokhtarian, P. A conceptual analysis of the transportation impacts Transportation 31(3) pp. 257-284, 2004
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Morgan, J., Orzen, H. and An Experimental Study of Price Dispersion Games and Economic Behavior, 54 2006
Sefton, M.
Nalebuff, B. Bundling as an entry barrier. Quarterly Journal of Economics. 119(1) pp. 159-187, 2004
Odlyzko, A. Privacy, Economics, and Price Discrimination on the In Economics of Information Security, (L. Jean Camp and S. Lewis,
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Odlyzko, A. The Evolution of Price Discrimination in Review of Network Economics Vol.3, Issue 3, 2004
Transportation and its Implications for the Internet
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Owen, S. Failures in B2C Companies: Two Examples and School of Finance and Economics, University of Technology,
Lessons for New Players Sydney in its series Working Paper Series with number 113, 2001
Pan, X., Ratchford, B. and Price dispersion on the internet: A review and Journal of Interactive Marketing, September 2004
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Pan, X., Ratchford, B. and The Evolution of Price Dispersion in Internet Retail Advances in Applied Microeconomics, volume 12, Organizing the
Shankar, V. Markets New Industrial Economy, pp. 85-105, 2003
Pan, X., Ratchford, B. and Can Price Dispersion in Online Markets be Explained Journal of the Academy of Marketing Science, special issue
Shankar, V. by Differences in e-Tailor Service Quality? "Marketing and Serving Customers through the Internet", 30 (4),
pp. 433-445, 2002
Pan, X., Ratchford, B. and Why Aren't the Prices of the Same Item the Same at eBusiness Research Center, Pennsylvania State University,
Shankar, V. Me.com and You.com? Drivers of Price Dispersion University Park, PA., 2001
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Pereira, P. Do lower search costs reduce prices and price Information Economics and Policy 17 pp. 61–72, 2005
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Porter, M. E. Strategy and the Internet Harvard Business Review 2001
Powell, T.C. and Dent-Micallef, Information Technology as Competitive Advantage: Strategic Management Journal (18) 5, pp. 375-405, 1997
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Primo Braga, C. E-commerce regulation: New game, new rules? The Quarterly Review of Economics and Finance 45, pp. 541-558,
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Lukosius, V.
Schaupp. L and Belanger, F.
Schmitz, S. and Latzerb, M.
Scholten, P and Smith, A
Scott-Morton, F., Zettelmeyer,
F. and Silva Risso, J.
Scott-Morton, F., Zettelmeyer,
F. and Silva Risso, J.
Scott-Morton, F., Zettelmeyer,
F., and Silva Risso, J.
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Title
Platform Competition in Two-Sided Markets.
Defining Two-Sided Markets
Two-Sided Markets: A tentative survey
Redefining industry structure for the information age
Internet Pricing: A Regulatory Imperative
E-tail Atmospherics: A Critique of the Literature and
Model Extension
A Conjoint Analysis of Online consumer satisfaction
Competition in B2C eCommerce: Analytical Issues
and Empirical Evidence
Price Dispersion Then and Now: Evidence from Retail
and E-tail Markets
Cowboys or Cowards: Why are Internet Car Prices
Lower?
Consumer Information and Discrimination: Does the
Internet Affect the Pricing of New Cars to Women
and Minorities?
Internet Car Retailing
Implications of buyer decision theory for design of e-
commerce websites
Geography and the Internet: is the Internet a
substitute or a complement for cities?
Pricing effects on foraging in a simulated Internet
shopping mall
The Law of One Price? The Impact of IT-enabled
markets on consumer search and retailer pricing
Consumer Decision-making at an Internet Shopbot
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Journal of the European Economic Association 1 (4), 2003
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Assessment in Understanding the Digital Economy:
Data, Tools and Research
E-Commerce capable: competitive advantage for
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Personalised Product Selection in Internet Business
Strategic advertising and pricing in e-commerce
Modeling of B2B mobile commerce processes
The impact of the Internet and consumer motivation
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Understanding The Digital Economy, MIT Press, 1999
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Torrubia, A., Mora, F. and Cryptography Regulations for E-commerce and Digital Computers & Security, Vol. 20, No. 8, 2001
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Turner, M. and Traynor, M.
Ulusoy, G. and Karabulut, K.
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Wang, C., Zhang, Y., Ye, L. and
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Electronic Commerce (EC Directive) Regulations Computer Law & Security Report Vol. 18 no. 6 2002
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Determination of the Bundle Price for Digital Mimeo 2003
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Competing Across Technology-Differentiated Management Science 51(3), pp. 483–496, 2005
Channels: The Impact of Network Externalities and
Switching Costs
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Yang, K. A comparative study of Internet regulatory policies in Telematics and Informatics, forthcoming 2006
the Greater China Region: Emerging regulatory
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Taiwan
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Zmud, J., Bricka, S. and Casas, Impact of Shopping via Internet on Travel for 80th Annual Meeting of the Transportation Research Board 2001
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